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After the collapse of the Bretton Woods regime in 1973 and the formation of the flexible exchange regime, once again economists began to survey the effects of currency depreciation on trade balance in both developing and developed countries. These studies have shown that at least in the short run, the traditional theory that supports the position effect of domestic currency depreciation on trade balance could have the reverse effect. In this paper, impulse response function and variance decomposition analysis in VAR and ARDL models have been seasonally utilized to examine the responses and dynamics of Iran's trade (goods) balance with that of Germany relative to the changes of the effective real exchange rate (Euro – Rial) during 1995-2004. In this investigation the short and the long – term effects have been estimated using two indexs of the effective real exchange rate. Results do not confirm the hypothesis of the existence of J-curve between the trade balance and the real exchange rate in the period under review, that is the responses of the trade balance relative to the rise in the exchange rate have been positive over both the short and the long – run and insignificant. On the other hand, the response of Iran's trade balance to its real income is significant i.e. by increasing Iran's real income; Iran's trade balance with Germany goes negative. In the case of Germany, the coefficient of real income on the trade balance proves insignificant although its sign is positive. It is noteworthy that, considering CUSUM and CUSUMSQ tests, all the coefficients are stable.
JEL Classification: F30, F32, F41