The Effect of the Exchange Rate on Industry-Level Trade Flows in Czechia

This paper is the first study to use the disaggregated data of the Czech foreign trade to examine the effect of exchange rate levels and volatility on trade flows. We analyze the period from 1993 to 2013 and disaggregate the data according to trading partner and product category. The detailed results obtained from empirical estimations clearly show that the relationship between exchange rates and foreign trade in Czechia does not completely correspond with the theoretical assumptions. We revealed that domestic currency depreciation worsens in the long-term trade balance in substantial parts of the Czech foreign trade, such as in the trade of machinery and transport equipment with Germany, Austria and France. We also found that an increased exchange rate volatility does not necessarily reduce foreign trade turnover, as the results for crude materials, fuels, chemical and manufactured products indicate. Therefore, although Czechia is a small, open economy, the exchange rate effects on foreign trade significantly differ in magnitude and direction across the trading partners and product groups.