The validity of Krugman's 45 Degree Rule in the axis of exchange rate and economic growth: A global analysis

It is argued that the difference of the growth rates between countries is based on the growth diversity of aggregate demand of the countries. The main factor that restricts economic growth in an open economy is the balance of international payments. Krugman (1988) stated that, although there are significant differences between countries? total production capacities, the real exchange rates remain the same which does not fit the theory. According to Krugman, countries? growth rate and the income elasticity of foreign trade can be reconciled if only there is a systematic relation between the two concepts. Krugman introduced the relation between the income elasticity of export and import demands and growth rate, and later named this approach as ?45 Degree Rule?. There is a linear relation between the rate of income elasticities of export demand over import demand and countries? growth rates.In this study, panel data analysis is applied to test the validity of Krugman?s 45 Degree Rule. The 14 countries (Australia, Austria, Belgium, Brazil, Canada, China, France, Germany, Italy, Japan, Holland, Turkey, England and United States of America) participated in this analysis are chosen from the G20 countries. Primarily, stationarity of the series, which generate the panel data, is analyzed with panel unit root tests. Afterwards, empirical results are obtained by the help of common correlated effects model. According to the empirical findings, Krugman?s 45 Degree Rule is valid for those 14 countries and there is a systematic relationship between these countries? growth rate and income elasticities of export and import demand.