The interplay of export supply and the real exchange rate. Evidence for Mercosur exports to the EU.

This paper applies a dynamic macroeconomic trade model to assess Mercosur-European Union trade. Looking at export supply of Mercosur countries (the four formal members plus Chile), the role of the real exchange rate, income and the income-absorption surplus or deficit are evaluated. Special emphasis is put on the reaction of exports with respect to changes of the real exchange rate. The model is tested for a sample of five countries (Argentina, Brazil, Chile, Paraguay and Uruguay) over the period of 1961-1996. A panel data analysis is used to disentangle the time invariant country-specific effects and to capture the relationships between the relevant variables over time. We find that the fixed effect model is to be preferred to the common effect model. The variables income and income-absorption surplus are found to be important determinants of trade flows. The real exchange rate has a positive and significant impact on export supply in the long-term, whereas current and past changes in the real exchange rate seem to play no role for current total export trade in the short-and medium-term. Having this latter time horizon, it could be shown that Mercosur´s total exports react extremely parsimoniously and slowly with respect to changes in the real exchange rate. This phenomenon could be due to the large share of agricultural and forestry products in Mercosur´s exports.