How sensitive are Britain's inpayments and outpayments to the value of the British pound

What is it about?

Purpose – To avoid aggregation bias by using trade data at bilateral level so that we can determine how sensitive are Britain’s inpayments and outpayments to the value of the British pound. Design/methodology/approach – The method is based on the bounds testing approach to cointegration and error-correction modeling. Findings – The main finding is that while UK inpayments are not sensitive to the exchange rate, her outpayments are. Research limitations/implications – Future research must concentrate on disaggregating data further, perhaps at commodity level. Practical implications – The results could be used to identify Britain’s trading partners against which Britain can devalue the pound and improve her trade balance. Originality/value – No study has attempted to test the impact of real depreciation of the pound on Britain’s payments and receipts with her major trading partners.

Featured Image

Why is it important?

Currency depreciation is said to improve a country’s trade balance if it lowers her outpayments and increases her inpayments. Most previous studies estimated trade flow equations to determine whether price elasticities in the import and export demand functions add up to more than unity, a condition known as the Marshall-Lerner condition which is said to be an indirect method of analyzing the effectiveness of depreciation. A direct way would be to relate a country’s inpayments (export value) and outpayments (import value) to the exchange rate in addition to other determinants. In this paper, we first outline the long-run relationships between the UK’s inpayments and real value of the pound in one relation and between the UK’s outpayments and the real value of the pound in another relationship. The models then are expressed in an error-correcting modeling format and estimated between UK and her 20 trading partners that include Australia, Austria, Canada, Denmark, Finland, France, Germany, Greece, India, Ireland, Italy, Japan, Netherlands, Norway, Singapore, South Africa, Spain, Sweden, Switzerland and the US. The empirical results showed that regardless of currency denomination, UK inpayments are not sensitive to real exchange rate changes.