What is REER

The aim of this chapter is to investigate the short and long-run impact of devaluation of the trade balance of Ethiopia. Devaluation has been used as a measure to improve trade balance. The data was collected from the World Bank for the years 1990 to 2017 and analyzed by applying an Autoregressive Distributed Lag (ARDL) approach and an Error Correction Model (ECM). The empirical findings show that the long run Real Effective Exchange Rate (REER) significantly and negatively correlated with the trade balance. The error correction coefficient which shows the adjustment of disequilibrium in the subsequent year is also significant. The empirical result indicated that devaluation of the Birr can improve the trade balance of Ethiopia. However, in reality, the trade balance of Ethiopia is not improved through a consecutive Birr devaluation. This may be resulted from the non-responsiveness of import to devaluation of the Birr, shortage of import substitute domestic products and the dependency of exports on primary agriculture products.