Investigating the Role of Economic Elements in Shaping the Trade Balance, and Reviewing the Twin-deficit Model and the Marshall-Lerner Condition: An Econometric Study on Bangladesh

Abstract

This study investigates the role of selected macroeconomic variables in shaping the trade balance of Bangladesh over the period 1980-2024. The analysis considers the exchange rate, budget deficit, terms of trade, inflation and economic growth as explanatory variables, with the trade balance as the dependent variable. The study applies time-series econometric techniques, including the Augmented Dickey-Fuller test, Johansen cointegration test and Granger causality test, to examine stationarity, long-run relationships and causal linkages among the variables. The ADF results indicate that all variables are stationary at first difference. The Johansen cointegration results show the presence of a long-run relationship among the selected macroeconomic variables. The estimated long-run coefficients indicate that exchange-rate depreciation and economic growth are positively associated with the trade balance, whereas the budget deficit, inflation and terms of trade are negatively associated with it. The positive relationship between exchange-rate depreciation and the trade balance supports the Marshall-Lerner condition in the context of Bangladesh. The negative relationship between the budget deficit and the trade balance also provides evidence consistent with the Twin-Deficit hypothesis. The Granger causality results indicate both unidirectional and bidirectional causal relationships among the variables. The findings suggest that improving Bangladesh's trade balance requires prudent fiscal management, export diversification, import management, trade facilitation and a stable macroeconomic environment.