The Effect of GDP & Exchange Rates on the Trade Balance Between the United States and Mexico

Abstract

The purpose of this study is to examine how the trade balance between the United States and Mexico is influenced by the Peso/Dollar exchange rate as well as US and Mexican GDP. This study also briefly examines the Marshall-Lerner condition and J-curve phenomena. Quarterly GDP and real exchange rate data are analyzed using a statistical regression where the independent variables are domestic GDP, foreign GDP, and real exchange rates. Results of the regression are used to explain movements in the trade balance in terms of the variables, as well as evaluate the sensitivity to each. The analysis is conducted from the U.S. perspective meaning that depreciation, a reduction in the value of the U.S. Dollar relative the Mexican Peso, results in a rise in U.S. exports and a fall in U.S. Imports. The sample period of this study is 1994-I to 2010-IV. It was selected because the revaluation of the Mexican Peso was complete by 1994-I. Two models are used to analyze the US Mexico trade balance one an elasticity approach and the other an absorption approach. Results from both models show a fall in United States GDP positively impacts the trade balance; while a drop in Mexican GDP negatively affects the trade balance. Most importantly results show that the trade balance displays an immediate positive reaction to a depreciation of the Dollar. Further, the effects of depreciation have a positive impact on the trade balance for an additional three periods following the depreciation. These results support the hypothesis that the Marshall-Lerner condition is met and provide no evidence of J-Curve patterns.