The traditional way of assessing the impact of currency depreciation and income on the trade balance has been to estimate the elasticity of trade volume to relative prices and income. The previous studies used aggregate data although they carry the problems associated with using aggregate data. The recent studies rely on bilateral data, yet another problem is that there are no available data for price of export and import. Thus, this study proposes an alternative way of assessing the impact of currency depreciation by using real exchange rate and the impact of income on bilateral trade. The models are applied between the EU and its major trading partners. Furthermore, the analysis includes the major six trading regions along side the major eight countries. Countries are Canada, China, Japan, Norway, Russia, Switzerland, Turkey and the US. Regions are new EU members and a candidate, which are Bulgaria, Romania and a candidate Turkey (NMCs), the Central and Eastern European countries, the European Free Trade Area (EFTA), the North American Free Trade Area (NAFTA), the Association of Southeast Asian Nations (ASEAN), and the dynamic Asian Countries (DAC). ). In 1990, 22.59 percent of exports and 25.28 percent of imports are from the selected countries/regions. In 2007 exports were increased to 36.58 percent and imports were increased to 36.57 percent.

Areas of interest in this study are the determination of the short run behaviour of the exchange rate movements on trade, testing whether the j-curve holds in the EU as a whole and finally testing the long run relationship between trade and variables such as exchange rate and income.  In this study import and export demand models were applied on the bilateral/regional basis by using the bounds testing (or autoregressive distributed Lag, ARDL) approach to cointegration, developed by Pesaran and Pesaran (2001). The ARDL approach involves two steps for estimating the long-run relationship (Pesaran et al., 2001). The first step is to examine the existence of long-run relationship among all variables in an equation and the second step is to estimate the long-run and short-run coefficients of the same equation. We run the second step only if we find a cointegration relationship in the first step. It was found that the EU’ exports and imports are insensitive to exchange rate movements (see the example of Japanese case in Bahmanee-Oskooee and Goswami, 2004). However, income appeared to be more significant in the long-run which indicating the higher importance of income compared to the real exchange rate in bilateral export and import demand functions.