Asymmetric Non Linear Response of Trade Balance to Real Exchange Rate Changes: A Case Study of Iran

The traditional theories of international economics emphasize on national currency devaluation as an efficient policy to enhance export, reduce import and consequently reduce current account deficit. The latest literature considers asymmetric response of trade variables to exchange rate changes and pays attention to ambiguous effect of reducing exchange rate on trade balance. This is an important finding since the success of trade policy depends on the understanding of the nature of trade balance behavior. The present paper examines Iran’s trade balance behavior in relation to exchange rate using logistic smooth transition regression (LSTR) during 1973-2009. The results of this research show that real exchange rate effects on Iran’s trade balance are asymmetrical and nonlinear. Furthermore, overvaluation of domestic currency effects negatively on the trade balance.