EXCHANGE RATE VOLATILITY AND ITS EFFECTS ON INTERNATIONAL TRADE FLOW IN SOUTH AMERICA

ABSTRACT

Due to the importance of the exchange rate in foreign trade and given that fluctuations in the exchange rate can modify the scale of prices among countries, this research aimed to identify the impact of the volatility of bilateral real exchange rate on trade flows among the South American countries. For that purpose, a gravity model was estimated using a sample of nine countries for a period between 1997 and 2011. The method used in the estimation of equations was the Poisson-Pseudo Maximum Likehood (PPML) model. The results showed that instability in exchange rates is detrimental to trade relations among the countries of South America, since greater exchange rate uncertainty pushes economic agents, in the long run, towards reducing their international trade activities due to high exposure to risk. Another important result was that Mercosul member countries have indeed benefited from the advantages offered by the block, such as the reduction of trade tariffs. Regarding the variable used to detect the effect of the subprime crisis in 2008, it was found an increase in the trade flow by South American countries in this period.

KEYWORDS:
exchange rate volatility; South America; gravity model; international trade