Effects of Monetary Policy on International Trade in Ethiopia

Table Contents

Acronym

CHAPTER ONE
1.1 INTRODUCTION
1.2 Statement Problem
1.3 Objectives
1.3.1 General Objectives
1.3.2 Specific Objectives
1.4. Scope of the Study
1.5. Significance of the Study
1.6. Organization of the Study

CHAPTER TWO
2. LITERATURE REVIEW
2.1. Theoretical Literature
2.2 Empirical Review

CHAPTER THREE
3. Research Methodology
3.1. Data Source
3.2. Model specification
3.3. Estimation Method
3.3.1 Unit roots
3.4 Diagnostic Tests

CHAPTER FOUR
4. Estimated Results and Interpretation
4.1 Unit Root Test
4.2. Testing for Bounds Test or Co-Integration
4.3. Diagnostic test Checking
4.4. Long run model
4.5 Short Run/Error Correction Model

CHAPTER FIVE
CONCLUSIONS AND RECOMEDATIONS
5.1 CONCLUSIONS
5.2 RECOMMENDATIONS

References

Acronym

Abbildung in dieser Leseprobe nicht enthalten

Abstract

This study examined the effect of monetary policies on Total Trade (proxy of international trade) in Ethiopia between 1989 to 2019.International trade was captured using Total Trade (proxy of international trade) while the independent variables that described the various macroeconomic policies in Ethiopia were money supply, exchange rate, real lending rate and inflation rate. Time series data on the variables of the study was gotten from Annual reports of the National Bank of Ethiopia (NBE) from 1989-2019. The secondary data was analyzed using E-views 9.0 software. A model was formulated for the study. The Augmented Dickey Fuller (ADF) stationary test showed that the variables in the study were stable at both levels and at first difference. The regression of the independent variables with Total Trade (proxy of international trade) showed the existence of a long run relationship. Using the Autoregressive Distribute Model (ARDL), the empirical results money supply exerts a significant positive effect on Total Trade (proxy of international trade) in the long run while real lending rate and inflation rate exerts a significant negative effect on Total Trade (proxy of international trade) in the long run and Total Trade (proxy of international trade) one period lag of the variable significantly affects the Total Trade (proxy of international trade) in the short run. LagTT or D(LTT(-1)), a one percent increase in expectation push Total Trade (proxy of international trade) by 51% in short run. This result is similar to the theory of adaptive expectations, they states that individuals will form future expectations based on past events. The study thus concluded that the monetary policy channels through which Total Trade (proxy of international trade) in Ethiopia can be influenced are money supply, lending rate and inflation rate. The study testes all the diagnostic test like serial correlation, Normality, heteroschedasticity and stability. The estimate of the speed of adjustment coefficient found in this study indicates that about a 75% of the variation in the Total Trade (proxy of international trade) from its equilibrium level is corrected within a year. The paper thus recommended that should promote policies that boost export such as reduction of export duty and Government should implement policies such as free tax Regimes, Technology transfer and loans for specific sectors to boost export diversification and drive up Total Trade (proxy of international trade) in the long run.

Keywords : Monetary Policy; Total Trade (proxy of international trade); Autoregressive Distribute Model (ARDL); Augmented Dickey Fuller (ADF); Ethiopia.

CHAPTER ONE

1.1 INTRODUCTION

Monetary policy is one amongst the macro-economic instruments with which nations do manage the economics. Economic growth is essential in an economy as it reduces poverty as well as improving livelihoods. The growing importance of monetary policy has made its effectiveness in influencing economic growth a priority to most governments. Despite the dearth of consensus among economists on how monetary policy actually works and on the magnitude of its effect on the economy, there's a noteworthy strong agreement that it's some measure of effects on the economy (Nkoro, 2005). Monetary policy is a combination of measures designed to regulate the value, supply and cost of money in an economy, in consonance with the expected level of economic activity (Folawewo and Osinubi, 2006). Ajayi (2014) opined that the objectives of monetary policy include price stability, maintenance of balance of payments equilibrium, promotion of employment and output growth, and sustainable development. The pursuit of price stability invariably implies the indirect pursuit of other objectives such as economic growth, which can only take place under conditions of price stability and allocative efficiency of financial markets. Monetary policy aims at ensuring that money supply is at a level that is consistent with the growth target of real income, such that non-inflationary growth will be ensured. Monetary policy influences economic growth through aggregate spending. Changes in money supply and interest rate influences consumer spending moreover investment decisions. Consequently, aggregate demand changes in response to monetary policy adjustments. For most economies, the objectives of monetary policy include price stability, maintenance of the balance of payments equilibrium, and promotion of employment, output growth, and sustainable development. These objectives are necessary for the attainment of internal and external balance, and also the promotion of long-run economic growth. The importance of price stability derives from the harmful effect of price volatility which undermines the objectives. This is often indeed a general agreement that domestic price fluctuations undermine the role of monetary values as a store useful, and frustrate investments and growth (Ajayi, 2014).

It entails those actions initiated by the monetary authorities who aim at influencing the cost and availability of credits (Wrightsman 1996).

Ethiopia monetary policy is enhanced to target the reduction in the rate of inflation with the framework of maintaining price stability as a single most important objective of monetary policy.

Generally, monetary policy refers to combination of measures designed to regulate the supply of money in an economy in relation to the level of economic activity. Monetary policy refers to the credit control measure adopted by the central bank of a country (Friedman, 2000).

On the other hand, International trade is simply known as the exchange of goods and services between nations of the world. At least two countries should be involved in the act, the aggregate of activities relating to trading between merchants across borders. Traders engage in economic activities for the profit maximization engendered from differentials among the international economic environment of nations (Adedeji, 2006).

International trade can be interchangeably referred to as ‘foreign trade’ or ‘global trade’. It encompasses the inflow (import) and outflow (export) of goods and services in a country (Frederick, 2012l).

Ethiopia has chronically run a negative balance of payments, rendering the country highly dependent upon foreign aid and loans to finance imports. Throughout the 1990s, the situation has shown little sign of improvement. Indeed, the balance of trade deficit was US$829.4 million in 1992 and despite a brief amelioration in 1994 when the deficit declined to US$609.5 million it remained approximately the same in 1998, when it reached US$830.0 million. The constant deficit ensures Ethiopia's perpetual indebtedness to the commercial banks of the rich industrial countries and international financial institutions, such as the IMF, the World Bank. In 1997, Ethiopia's total external debt stood at US$10 billion.

Ethiopia's major exports include coffee, gold, leather products, beeswax, canned vegetables, tea, sugar, cotton, and oilseeds. Purchasing approximately 22 percent of Ethiopia's exports in 1997, Germany is Ethiopia's largest trading partner. Along with many other countries of EU such as Italy, France, and the United Kingdom Germany has steadily increased its quantity of Ethiopian imports. In 1992, for instance, the countries of the EU purchased approximately Br203.3 million worth of Ethiopian exports, whereas this figure increased dramatically to Br1, 351.5 million in 1996. Similarly, the United States has increased its quantity of Ethiopian imports from Br19.6 million in 1992 to Br169.9 million in 1996. This major increase in trade with the Western countries can be explained primarily by the fall of the Derg and the subsequent liberalization policies pursued by the EPRDF. Other major importers of Ethiopian products include Saudi Arabia, China, and Japan, the latter of which purchased 12 percent of all Ethiopian exports in 1997. Ethiopia's largest trading partner in Africa is Djibouti, a neighboring country through which Ethiopia must conduct all of its importing and exporting since Ethiopia is landlocked and thus lacks a port of its own.

Ethiopia's major imports include food and petroleum and petroleum products, chemicals, machinery, civil and military aircraft, transport and industrial capital goods, agricultural machinery and equipment, and motor vehicles. Ethiopia's imports have followed the same pattern as its exports in the 1990s, with the percentage of imports from the countries of the EU and the United States steadily increasing. In 1991, imports worth Br364.7 million were purchased from the countries of the EU, while this figure increased to Br2,006.7 million in 1995. In the same year, a similar value (Br 2,300.7 million) of imports came from various countries of Asia and the Middle East, including Japan, Saudi Arabia, and China. With imports to Ethiopia equaling Br146.8 million in 1995, Djibouti is Ethiopia's number-one regional exporter, while Kenya is second (IMF, International Financial Statistics Yearbook 1999).

Ethiopia's balance of trade deficit can be largely explained by the unequal terms of trade between agricultural commodities (the country's major exports) and capital goods (Ethiopia's major imports). International markets accord a higher price to commodities that are manufactured or "value-added" than to those that are in their raw form. Recognizing the uneven terms of international trade, many countries, including Ethiopia, pursued policies of protectionism throughout the 1960s and 1970s to develop national industrial capacity or import-substitution . In many cases, where the state pursued policies of complete industrial control, they failed miserably. For others, however, such as the economies of Southeast Asia, the policies were more successful, enabling these countries to eventually partake in liberalized free trade at the global level.

Countries would be limited to goods and services produced within their territories without international trade. International trade is directly related to globalization because increase in trade activities across border is paramount to the globalization process. The globalized nature of an economy enhances its direct participation in the world market consequently leading to market expansion. According to Adam Smith, as quoted in Li, Chen and San (2010) opine that expansion of a country’s market encourages productivity which inevitably leads to economic growth. In view of this, the study aims to provide evidence on the effect of monetary policy on international trade of Ethiopia.

1.2 Statement Problem

Monetary policy as a technique of economic management to bring about sustainable economic growth and development through foreign trade has been the pursuit of nations and formal articulation of how money affects economic aggregates dates bank the Adams Smith and water championed by the monetary economists. Since the expositions of the role of monetary policy in influencing macroeconomic objectives like economic growth price stability, equilibrium in the balance of payments, and a host of other objectives, monetary authorities are saddled the responsibility of using monetary policy to grow their economies.

One of the major objectives of monetary policy in Ethiopia is price stability. But despite the various monetary regimes that have been adopted by the National Bank of Ethiopia over the years, inflation still remains a major threat to Ethiopia’s economic growth.

Ethiopia has experienced increases in inflation rates. The growth of money supply is correlated with the high inflation episodes because money growth was often in excess of real economic growth. However, preceding the growth in money supply, some factors reflecting the structural characteristics of the economy are observable.

Some of these are supply shocks, arising from factors such as famine, currency devaluation and changes in terms of trade. The cause of the inflation may also be adduced to the worsening terms of external trade experienced by the country at that time.

The economy has also witnessed times of expansion and contraction but evidently, the reported growth in foreign trade has not been a sustainable one as there is evidence of growing poverty among the populaces.

1.3 Objectives

1.3.1 General Objectives

The major objective of this study is to investigate the effects of monetary policy on International Trade in Ethiopia.

1.3.2 Specific Objectives

i. Examine the impact of monetary policy on International Trade.
ii. Investigate the impact of inflation rate on International Trade.
iii. Investigate the impact of exchange rate on International Trade.
iv. Investigate the impact of real lending rate on International Trade.

1.4. Scope of the Study

This study focuses on investigating monetary policy and International Trade in Ethiopia. The study will be making use of data collect mainly from secondary sources that are statistical bulletins from NBE. The study covers the period 1989-2019. This is sufficient and suitable for conducting a research, making new findings and relevant recommendations.

1.5. Significance of the Study

The study is to expand the existing stock of literature on Effect of Monetary policy on International Trade in Ethiopia. It is also intended to provide information to policy makers to enable them come up with appropriate policies to emphasize the effect of the government’s actions through monetary policy on International Trade, which will immensely contribute to current knowledge on the topic under research.

1.6. Organization of the Study

This paper is stratified into five sections. Section one include the introduction of the study, section two consist of the theoretical and empirical review, section three describes the research methodology undertaken in this study, section four present the empirical findings while section five consist of drawn the main conclusions and recommendations.

CHAPTER TWO

2. LITERATURE REVIEW

2.1. Theoretical Literatur e

The Monetary policy is all about the control of money supply by the monetary authority of a country mostly targeting on either inflation rates or interest rates to stabilize the macro economies such as price stability, exchange rates stabilities and low unemployment of the county. As a macroeconomic instrument, monetary policy is employed by the monetary authority to ensure proper management of the economy to achieve intended and desired goals (Imoughele,2014).This implies that monetary provides the baselines for meeting certain economic targets. Afolabi et al. (2018) posited that monetary policy serves as a key tool for economic stabilization for regulating the cost and availability of money or credit in the economy. Thus, the regulation of the monetary policy variable helps in controlling distortions in the economy. The objectives of monetary policies include: the maintenance of price stability; maintenance of balance of payment equilibrium; attainment of high rate of employment; accelerating the pace of economic growth and development; and exchange rate stability. The techniques by which the stated objective is pursued by the monetary authorities can be classified into two categories:-the Market Control Approach and the Portfolio Control Approach. The Market Control Approach is an indirect or traditional approach of monetary control which includes the manipulation of Open Market Operations (OMO) and the Central Bank’s Discount Rate. While the Portfolio Control Approach is a direct or non-traditional approach of monetary control. It works through the instruments of portfolio constants, namely: Reserve requirements, Special deposits with the Central Bank, Selective credit controls, Moral suasion, Direct Measures.

The theoretical foundations for this study include the Keynesian theory of monetary policy and the classical theory of foreign trade. These theories established the relationship between monetary policy and foreign trade in an open economy as well as the principles upon which foreign trade will take place in such an economy. The monetary analysis provided by Keynes (1936) is anchored on the principles of effective demand. For Keynes, changes in output and employment are predicated on changes in aggregate demand. Thus, monetary policy tends to produce some real effects on the output growth. Unlike the classical theorists, Keynes advocated the role of the government in stimulating output and aggregate demand through the indirect role of the central banks. The channel through which monetary policy can affect output and employment is through changes in interest rates which stimulate investment. Although Keynesian economists admits that monetary policy can be helpful in stimulating output, they emphasized on large fiscal stimulus which involves expansion of government spending or reduction of taxes as monetary policy seems inadequate in facilitating overall revival of the economy through production and output growth. The ultimate goal of monetary expansion in the view of Keynes is to satisfy an unmet demand for money (Jahan et al., 2014). This focuses mainly on decline in the level of interest rate which increases investors’ access to funds to stimulate investment.

The Keynesians on the other hand believe that variations in money supply could lead to an increase or decrease in interest rate. A decrease in interest rate will affect aggregate investment and enhance aggregate income and output. This is based on the belief that interest rate is the key determinant of investment in the market economy. The investment process involves the employment of factors such as labor and capital which lead to increase in total employment.

The monetarists base their views on money supply as the key factor affecting the wellbeing of the economy. They believe that an increase in money supply will lead to an increase in nominal demand, and where there is excess capacity, they believe that output will be increased. In the long-run, the monetarist position is that the increase in money supply will be inflationary without any effect on investment, employment and aggregate demand.

Government adopts various economic policies, which are implemented in the economy in order to influence economic activities. In doing this, the aim of the government is to achieve some target considered desirable for the economy.

The major drawback of the Keynes theory is its assumption that interest rate is the only channel through which monetary policy affects demands. However, Mishkin (1996) outlined changes of exchange rate, financial assets prices, and bank-lending capacity among other channels through which monetary policy stimulate overall demand.

The classical theory of international trade is mostly based on the doctrine of comparative advantage. It strongly asserts that trade in a two country model is facilitated in the difference of overall advantage in terms of technology, economy, social status etc. furthermore he went further to note another important factor which affects comparative advantage. According to Ricardo, differences in climate and environment tend to result in differences in comparative advantage; differences in comparative advantage lead to trade. Thus, the business climate as well as the environment play important role in foreign trade. So, if the business climate is favorable for foreign interests base on the prevailing monetary policies of a country, this may go a long way in inducing foreign trade. Furthermore, in the context of a model of two countries, two commodities and one factor of production, Ricardo obtained the result that a country will tend to export the commodity in which it has a comparative advantage and to import the commodity in which it has a comparative disadvantage. Since comparative costs are the other side of comparative advantage, the classical theory is easily couched in terms of comparative costs. Specifically, the theory now states that a country will tend to export the commodity whose comparative cost is lower in autarky and import the product the comparative cost of which is higher in pre-trade isolation.

2.2 Empirical Review

Various empirical studies have been carried out to establish the effect of monetary policy variables on macroeconomic performance of developing countries via foreign trade relations. This interest is buoyed by new studies favoring the export-led growth hypothesis, thus identifying monetary policies that positively influence exports and stabilizes imports is essential for developing countries like Ethiopia. Thus, a review of these related studies are presented below.

Onuchuku et al., (2018) studied the effect of monetary policy variables on economic growth and balance of payment in Nigeria using Ordinary Least Squares (OLS) method. The study found that money supply has positive impact on the growth of gross domestic product (GDP) and balance of payment while money supply has negative impact on rate of inflation in the economy. Similarly, Chipote &,Makhetha-Kosi(2014) adopted error correction mechanism to examine the impact of monetary policy variables on economic growth in South Africa, and discovered that money supply and exchange rate have insignificant impact on economic growth in South Africa whereas the money supply has significant impact on inflation Articles.com.ng (2017) displayed the work of an unknown author who examined the impact of monetary policy on foreign trade in Nigeria. The study employed quantitative analysis approach. The data collected from a period of 1981-2010 on appropriate indices for monetary policy (money supply, Interest rate, Exchange rate, inflationary ratio and liquidity ratio) were analyzed using multiple regression analysis. The model employed for the study was estimated using the ordinary least square technique. The result showed that money supply, exchange rate, inflationary rate exerted negative influence on foreign exchange. Based on the findings, the study concluded that a clear-out and obvious relationship existed between monetary policy and foreign trade in Nigeria and recommends for conscious efforts to be made to fine-tune the various monetary variables in order to provide an enabling environment to stimulate foreign trade. Eze and Atuma (2017) examined the effect of monetary policy variables on net export of Nigeria for the period 1981-2016.Auto Regressive Distributed Lag (ARDL) bounds co-integration test and its associated ARDL short-run and long run coefficients test and Pairwise Granger causality test were utilized in the analysis. The results also indicated that money supply (LMS) has positive insignificant effect on net export of Nigeria while total export (LTEXP) has positive significant effect on net export of Nigeria. Similarly, the results showed that interest rate (INR), exchange rate (LEXCR), foreign direct investment (LFDI) and total import (TIMP) have negative insignificant effect on net export of Nigeria. More so, the results of the Pairwise Granger causality test indicated that money supply (LMS) has unidirectional relationship with net export (NEX) with significant causality runs from money supply (LMS) to net export (NEX). The results however, indicated no significant causality between NEX and INR, LEXCR, LFDI, TEXP and TIMP. Thus indicating that any economic policy that targets increase in money supply and promotion of the total export of goods and services will lead to increase in net export of Nigeria while any attempt by the government to raise interest rate, exchange rate, foreign direct investment and import of goods and services will bring down the growth rate of net export of Nigeria. Based on these findings, the study recommended that government should rely much on the increase of money stock in the economy in promoting net export of Nigeria. Lawal (2016) investigated the effect of monetary policy operations on the performance of the manufacturing sector in Nigeria from 1980-2015. The study employed the Ordinary Least Square (OLS) method to estimate the relationship between the variables in the model. Error Correction Model (ECM) was employed to ascertain the short-run dynamics of coefficients of the regressors included in the model and the speed of adjustment. The results revealed that broad money supply is positively and significantly related to manufacturing output in both short run and long run. Exchange rate exerted significant positive effect on manufacturing output in the long run, but its effect in the short run is negative. The study concluded that broad money supply is the largest driver of manufacturing output in the long run. The study recommended that the Central Bank of Nigeria should provide a policy thrust and requisite checks on the activities of deposit money banks to promote compliance in the provision of credit to the private sector in order to boost manufacturing activities. Usman and Adejare (2014) empirically examined the impact of monetary policy on industrial growth in Nigerian economy, in line with the objectives of this study, secondary data were obtained from central bank of Nigeria statistical bulletin covering the period of 1970 to 2010. Multiple regression analysis was employed to analyze data on variables such as manufacturing output, Treasury Bills, Deposit & leading and Rediscount Rate. They were all found to have significant effects on industrial Growth with the Adjusted R[2] of 0.8156 (81.56%). Following this outcome, the study therefore concluded that Rediscount Rate, and Deposit had significant positive effect on industrial output but Treasury Bills had negative impact on industrial output. It is recommended that government should develop the industrial sectors of the economy through its capital expenditure on productive activities and social overheads as they will contribute positively to industrial growth which will invariably enhance economic growth.

Nenbee and Madume (2011) investigated the impact of monetary policy on Nigeria’s macroeconomic stability between 1970 and 2009. The study viewed macroeconomic stability in terms of price stability. Data analysis techniques employed were Cointegration and Error Correction Modeling (ECM). The results of the study revealed that only 47% of the total variations in the model are caused by the monetary policy variables Money Supply (MS), Minimum Rediscount Rate (MRR), and Treasury Bills (TRB) at the long run. The study showed that the monetary policy tools showed a mixed result in terms of their impact on inflation in Nigeria. Therefore the study recommended that Nigeria should adopt macroeconomic mix of monetary, fiscal and exchange rate policies in managing inflation thereby promoting price stability which ultimately leads to macroeconomic stability. Udude (2014) examined the impact of monetary policy instruments on economic growth in Nigeria for the period 1981-2012 using Vector Error Correction Mechanism (VECM). The study discovered that only exchange rate exerted significant impact on economic growth in Nigeria within the period studied. Nwoko et al., (2016) utilized OLS in investigating the influence of monetary policy measures in Nigerian economy. The study revealed that average price and labour force have significant influence on gross domestic product while money supply has insignificant influence on the growth of Nigerian economy. Ajisafe & Folorunso (2002) examined the relative effectiveness of monetary and fiscal policy on economic growth in Nigeria using cointegration and its associated error correction model (ECM) techniques from 1970 to 1998. The study showed that monetary rather than fiscal policy exerts a greater impact on economic growth in Nigeria and concluded that emphasis on fiscal action by the government has led to greater distortion in the Nigerian economy. More so, Chukuigwe and Abili (2008) investigated the impact of monetary and fiscal policies on non-oil exports in Nigeria for the period 1974-2003 through the application of ordinary least squares (OLS) estimation method. The study indicated that both interest rate and exchange rate have negative influence on non-oil exports, while budget deficits had negative effect on non-oil exports of Nigeria.Ogar et al.,(2014) investigated the influence of the instruments of fiscal and monetary policies on the growth of Nigerian economy for the period of 1986-2010. The study was set to find the monetary and fiscal policy instruments determinants that significantly impacted on economic growth of Nigeria. The study used the method of ordinary least squares (OLS) in the data analysis. The results showed that government revenue has significant and positive impact on economic growth. Similarly, it was revealed in the study that money supply has significant positive impact on economic growth. The study also found that exchange rate has positive impact on the performance of the Nigeria’s economy. However, the Imoisi et al., (2013) examined the effect of monetary policy on Nigeria’s payments balance stability for the period from 1980 to 2010. The research employed the method of OLS in the analysis. The study discovered that interest rate and supply of money have significant and positive impact on payments balance position of Nigeria.

Most studies carried out sought to determine the relationship between monetary policy and economic growth in Nigeria, few took a sectorial approach, analyze and determined the impact of monetary policies on the channels of foreign trade that contribute significantly to economic growth. However, economic theory postulates that sustainable economic growth can be achieved rapidly with optimum foreign trade i.e. achieving a balance between imports and exports. Secondly, most studies reviewed did not cover a longer period, thus inadequately accounting for various shocks and causal effect that would manifest from changes in one monetary policy in favor of the other. Hence, what is need is a more dynamic model that shows both the short run and long run relationship between monetary policy and foreign trade. This study also uniquely disaggregated foreign trade into total export and total imports for the period under study. The study used a broader spectrum of monetary implementations comprising exchange rate, interest rate, monetary supply cash reserve ratio, minimum rediscount, it analytical technique which is quite different from others choice of variables in the studies renewed.

CHAPTER THREE

3. Research Methodology

3.1. Data Source

The study uses are secondary data collected from the National Bank of Ethiopia (NBE) annual time series data from 1989 to 2019.

3.2. Model specification

The study adopted the Quasi-experimental design because the study deals with time series data. The data for the study was annual time series data with the required time frame spanning the period 1989 to 2019. The variables that were used for the study are Total Trade (a proxy for international trade), Money Supply (M2), Real Lending Rate (RLR), Exchange Rate (EXR) and Inflation Rate (IR).The econometric software E-views 9.0 was used in running the model. The study adopted both descriptive and analytical statistics to examine trends and relationships of the variables. The Augmented Dickey-Fuller test was employed as a test of stationarity. The Auto-Regressive Distributed Lag (ARDL) Bounds testing was also used to test for the long-run and short run relationship among the variables. The method of estimation employed for this study is based on Auto-Regressive Distributed Lag (ARDL) Model approach both long-run and short-run ARDL models.

Variables definition and expected signs

The paths of Total Trade (a proxy for international trade) in small open economy like Ethiopia may be determined by the following explanatory variables definition and expectation signs

Money Supply (M2): Are the entire stock of currency and other liquid instruments circulating in a country's economy as of a particular time. The money supply can include cash, coins, and balances held in checking and savings accounts, and other near money substitutes. Economists analyze the money supply as a key variable for understanding the macro economy and guiding macroeconomic policy. An increase in the supply of money typically lowers interest rates, which in turn, generates more investment in the international trade but these concepts truly function properly use supply money in the market. Therefore, it increases the international trade of the country. Thus, the Money supply has a positive Expectation sign-on international trade.

Inflation Rate (IR): Monetary policy should be tightened to achieve single digit inflation since investors both private and foreign may not be willing to invest in an environment with high inflation rate (Dobrinsky, 2005). Often expressed as a percentage, inflation thus indicates a decrease in the purchasing power of a nation’s currency.

The framework envisages an inverse relationship between inflation and international trade as increase in the rate of inflation may discourage international trade investment. Therefore it can be expected that this is a negative relationship on international trade investment.

Exchange Rate (EXR): is the rate at which one currency will be exchanged for another. The exchange rate has an effect on the trade surplus or deficit, which in turn affects the exchange rate, and so on. In general, however, a weaker domestic currency stimulates exports and makes imports more expensive. Conversely, a strong domestic currency hampers exports and makes imports cheaper. Therefore, Exchange rate increase international trades of countries are increase. Thus, the Exchange Rate has a positive Expectation sign-on international trade.

Real Lending Rate (RLR): Lending rate is the bank rate that usually meets the short- and medium-term financing needs of the private sector. This rate is normally differentiated according to creditworthiness of borrowers and objectives of financing. The terms and conditions attached to these rates differ by country, however, limiting their comparability. Interest rate has an indirect effect and negative relationship on international trade investment. When interest rates increase, international trade investment decreases because the loans will cost much more to repay therefore demand for credit by private sector falls and when interest rate fall then demand for credit rises as the cost of financing investments reduces (Friedman, 1978). The sign of the real lending rate is an empirical issue but as it is the opportunity cost of investment, probably it would affect international trade investments negative.

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