An Empirical Investigation of Orcutt’s Hypothesis: Evidence from Selected Developed and Developing Countries

International Journal of Research and Innovation in Social Science (IJRISS) | Volume II, Issue VIII, August 2018 | ISSN 2454–6186

An Empirical Investigation of Orcutt’s Hypothesis: Evidence from Selected Developed and Developing Countries

Khaliq ul Rehman¹, Masood ur Rehman Azhar², Saima Masood³, Dr. Nor Malina Malek⁴

¹Quaid-i-Azam University, Islamabad, Pakistan
²School of Social Sciences, UniversitiSains Malaysia
³Lecturer, COMSATS University Islamabad, Wah Campus, Pakistan
⁴Associate Professor, School of Social Sciences, UniversitiSains Malaysia

Abstract: – The present research focuses on Orcutt’s (1950) hypothesis which explains that trade flows disturb/fluctuate in response to change in exchange rate more rapidly as compared to changes in prices. For empirical analysis, the study has used annual data. Based on the availability of the data the study has used the different time periods for the selected developed and developing countries. While for estimation process, we use ARDL and error correction model. The empirical results show the common behaviour among the selected countries that import flows are influenced more quickly in response to change in relative prices than exchange rate whereas, the results of the export side are mostly inconclusive, but in some cases the Orcutt’s hypothesis holds. The study finds out that the Orcutt’s hypothesis holds in very limited case.

Key Words: Orcutt’s hypothesis, trade flows, exchange rate, relative prices, ARDL bound test, and ECM

I. INTRODUCTION

In open economy, the flows of export and import have great importance as these are major components of the aggregate demand which are managed through different policy tools like fiscal and monetary policy. For trade balance to improve, we need to check which factors affect flows of both imports and exports. Exchange rate and relative prices are important factors which affect the trade flows. For investigating the impact of any shock related to trade flows (export and import) we require to know how exchange rate and relative prices influence them. It is important in particular if the export reduces due to decrease in the demand of exports in the international market, the country faces the problem regarding policy action or option that whether the exchange rate devaluation or decrease in relative prices by using tariff and subsidies be used. These two policy options; devaluation of the exchange rate or decrease in relative prices are considered to be the two widely accepted or recommended option to correct for trade balance which in the literature known as Orcutt’s hypothesis.

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