An Empirical Investigation of the Relationship between the Exchange Value of the Pound and the UK Trade Balance

In this article we investigate the relationship between the exchange value of the pound and the U.K. trade balance (and its components) for the period running from the second quarter of 1973 to the third quarter of 1989, i.e. roughly the floating rate era from the end of the Bretton Woods System to the entry of the UK in the European Monetary System. Using Johansen cointegration techniques and testing for Granger causality, we find no evidence favouring the Y-Curve hypothesis. Our results are more compatible with the accomodative role of the real exchange rate claimed by the so-called modem theory of trade balance. They suggest that changes in exchange rates are as much a consequence as a cause of trade movements.