Mercado Comun del Cone Sur (henceforth, MERCOSUR) was inaugurated as a tariff union to create EU-type free trade market between four countries (Argentina, Brazil, Paraguay and Uruguay) in January 1995.
At present, Bolivia and Uruguay adopt a crawling band and a crawling peg exchange rates system, respectively, in order to stabilize exchange rates against the U.S. dollar. On the other hand, Paraguay adopts a managed floating exchange rates system, and Argentina, Brazil, and Chile adopt free-floating exchange rates system. For this reason, the bilateral exchange rate between two countries in MERCOSUR, such as Brazilian real—Bolivian nuevo boliviano would fluctuates, when exchange rates of real against the U.S. dollar change. Since an increase of exchange rates volatility acts so as to increase exchange rate risk, if export and import trader are risk-averse agent, there is a possibility that exchange rates volatility has a negative impact on international trade flows.
The purpose of this paper is to examine the impact of real effective exchange rates volatility of Brazilian real on Brazil-MERCOSUR trade flows.
As a result, we find that volatility of real effective exchange rate of real has a significant negative effect on trade flows for MERCOSUR countries in the short run and long-run. This means that it is necessary for Brazil to adopt exchange rate system that stabilizes the currency basket reflecting the relation of foreign trade in order to expand the trade for MERCOSUR countries.
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