The purpose of this paper is to analyze the effects of change in exchange rate of Birr onrnthe trade balance of Ethiopia. The study employs the standard Augmented Dickey-Fullerrntest in order to test the stationarity of all variables at levels and first differences and thernJohansen and juselius' approach to estimation of multivariate co integration systems onrnthe quarterly data in the period 1970/ 71QI - 2005/06QI. In order to establish thernexistence or absence of a j-curve phenomenon in Ethiopia, we employ impulse responsernfunction to trace the effect of real effective exchange rate on the trade balance ofrnEthiopia.rnThe main findings of the study show that: first, there is a negative relationship betweenrnthe trade balance and the real effective exchange rate appreciation indicating that a realrndepreciation will improve the trade balance in the long run; second, the results indicaternthat there seem to be no clear evidence of the J-curve phenomenon.rnThe policy implication of the finding is that to improve its international competitivenessrnand its trade balance deficit, Ethiopia can use depreciation/devaluation basedrnadjustment policy. Competitiveness, however, goes beyond currency depreciation. I.e.rncurrency depreciation alone is unlikely to be able to increase competitiveness.rnTherefore, Ethiopia has to use also export diversification strategy i.e. the governmentrnhas to pursue to diversify export commodities from agriculture to other products bothrnvertically and horizontally in order to be competitive and reduce its trade deficit sincernmost of export items relied on few primary commodities.rnThe negative sign of domestic real income indicated that a rise in domestic income ofrnEthiopia encourages its consumers to demand more foreign goods, leading to arndeterioration of trade balance in favor of its major trading partners. In this regard, therngovernment has to promote import substitution strategy In order to shift the demand ofrndomestic consumers towards domestic goods.