Exploring Long-Run and Short-Run Dynamic Interaction among Real Exchange Rate, Economic Growth, Balance of Trade and Inflation: Insights from Bangladesh

Abstract

Introduction: This study investigates the dynamic interaction among the real exchange rate, economic growth, inflation, and the balance of trade in Bangladesh over the period 1986–2022. Understanding these interdependencies is crucial for formulating effective macroeconomic policies, as fluctuations in these variables can significantly influence the country’s economic stability and growth trajectory.

Objectives: The primary objective of this study is to analyze the short-run and long-run relationships among the real exchange rate, economic growth, inflation, and balance of trade. Additionally, it aims to examine the causal relationships among these macroeconomic variables to understand their interdependencies. Furthermore, the study seeks to explore policy implications for effectively managing inflation, exchange rates, and trade performance to ensure sustainable economic growth.

Methods This study employs the Auto Regressive Distributed Lag (ARDL) model to analyze both short-run and long-run dynamics among the variables. Additionally, the Granger causality test is conducted to identify the direction of causality among economic growth, inflation, real exchange rate, and balance of trade.

Results: The findings highlight significant interdependencies among the selected macroeconomic variables. Inflation positively influences economic growth within certain thresholds, while the exchange rate plays a critical role in shaping both economic performance and trade balance. The study also identifies a bidirectional Granger causal relationship between economic growth, inflation, and balance of trade. Moreover, a unidirectional causality is observed from inflation to the real exchange rate. Despite these interactions, challenges such as inflationary pressures and trade deficits persist, affecting economic stability.

Conclusions: This study underscores the necessity of a comprehensive macroeconomic policy approach to manage the interplay among inflation, exchange rates, and trade performance. Policymakers should focus on coordinated strategies to sustain economic growth while mitigating inflationary risks and improving trade balance. Further research on external shocks and their macroeconomic effects is essential to strengthen economic resilience and enhance Bangladesh’s position in the global market.