Oil Prices, Exchange Rates, and the Trade Balance: Evidence from Kazakhstan and Russia

This paper studies the exchange rate effect on the trade balance for the major oil exporters Kazakhstan and Russia. Results from baseline tests of the Marshall Lerner condition indicate that an exchange rate depreciation actually decreases exports and deteriorates the trade balance, the opposite of traditional theory! To understand the results, the paper first augments the traditional theory to take into account the behavior of oil prices in the export and trade balance equations. The augmented theory posits that a decrease in the oil price leads to a real exchange rate depreciation and a decline in exports, thereby creating the positive correlation seen in the baseline results. In accordance with the augmented theory, the regression results suffer from omitted variable bias; when the oil price is taken into account the results again support the theory.