Thesis (Ph.D.) - Cairo University - Faculty of Economics and Political Science - Department of Economics

This study explores whether real exchange rate misalignment has any effects on the trade balance and output gap in Egypt during the period (1974-2012). In order to empirically examine the link between exchange rate misalignment and trade balance during this period, time-series econometric tools including unit root tests, co-integration analysis and vector error correction model are employed. The empirical results show that there exists a negative relationship between the misalignment of the real exchange rate and the trade balance in Egypt. A deviation of the actual real effective exchange rate from its equilibrium level by 1 percent leads to a deterioration of the trade balance that ranges between 0.03 and 0.07 percent. Both undervaluation and overvaluation of the Egyptian pound may negatively affect the performance of trade balance based on the misalignment model used. Also, there is no evidence for the presence of the J-curve hypothesis in the case of Egypt. The generalized method of moments is used to quantify the effect of real exchange rate misalignment on output gap during the same period. The findings suggest a weak positive relationship between the two variables. In particular, a 1 percent increase in misalignment has an impact that does not exceed 0.07 percent on output gap. As regards the effects of undervaluation and overvaluation indices, they all seem, though weakly, to impact the output gap positively in the Egyptian case. These findings suggest that if Egypt wants to reap benefits from its overall economic reform process, efforts for redirecting monetary policy towards correcting exchange rate misalignments should be motivated. Moreover, industry and other productive sectors modernization should be at the top of the Egyptian policy agenda to promote exports and improve the trade balance.

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