Does Any Long-Run Relation Exist Between the Terms of Trade and the Trade Balance?

In this paper we use the Johansen and Juselius cointegration technique t examine the long-run convergenCe between the trade balance and the terms o trade, using quarterly data from Sweden. The results show that the trade balance and the terms of trade are cointegrated in the long run and the trade balance is positively correlated with the terms of trade. This implies that productivity gap between the domestic economy and the rest of the world, implying technological shock to the domestic economy, affects the trade balance. The policy implication of our findings is that the use of the origina1 Marsha Lerner condition is no longer sufficient as a justification for currency depreciation and the condition may be excessively conservative when the pricing to market phenomenon is important in explaining the evolution of the external trade balance.