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How Does National Foreign Trade React to the European Central Bank’s Policy?

This paper examines how external foreign trade reacts to the European Central Bankâ€™s (ECB) Official Discount Rate, considering exports to the US and Japan in EU27 and in four European countries. Although many previous studies have measured the cointegration and causality among exchange rate, exports, and imports, to date, no research has considered these relationships while introducing monetary variables into the analysis. The objective of this article is to fill this gap in the literature. We use the bounds testing approach to cointegration and error-correction modelling to test relations between monetary policy, exports, and terms of trade, making the distinction between short and long-run effects possible. Our datasets include quarterly data on exports, imports, income, relative price, and the official ECB discount rate. The quarterly data starts from the first quarter of 1999 and ends in the last quarter of 2008. The results show that a long-run relationship exists between real exports, real foreign income, real bilateral cross rates and interest rates for a large part of these countries. Also long run parameter estimates are consistent with economic theory in most of the cases. More importantly the statistically significant error-correction term corroborates the results of the long-run parameter.