Testing Long Run Relationship between Exports and Imports: Evidence from Pakistan

Abstract

Exports and imports together play an integral role in determining the trade balance of a country. In this respect the dynamics of relationship between these variables hold significant importance and attract the researchers for testing the nature of relationship between exports and imports. This study empirically examines the long run relationship between exports and imports for Pakistan using quarterly data for the period 1972-2006. The econometric framework used for analysis is the Johansen Maximum Likelihood cointegration technique, which tests both the existence and the number of cointegration vectors. Results show that there is a long run relationship between exports and imports and the country is not in violation of its international budget constraint. Furthermore, for testing the stability of long run equilibrium relationship and direction of causality, vector error correction model (VECM) technique has been applied. The findings confirm the stability of the long run equilibrium relationship between exports and imports. Under Granger causality tests, it has been found that there exists bidirectional causality between exports and imports. Therefore, it suggests that overall macroeconomic policies are effective in bringing exports and imports into a long run steady state equilibrium. Conclusively, the trade balances are sustainable in the long run for Pakistan.