J-Curve

3 Key excerpts on "J-Curve"

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  International Finance

  Contemporary Issues

  • Maurice D. Levi, Dilip Das(Authors)
  • 2007(Publication Date)
  • Routledge

    (Publisher)

  J-Curve effect.

  Figure 6.10b shows what might happen after an appreciation of the exchange rate if imports and exports are more inelastic in the short run than in the long run. The figure shows that after an appreciation at time 0, the associated decline in import prices could reduce spending on imports. If the value of exports does not decrease as much as the value of imports declines, the balance of trade will improve from the currency appreciation – not what one would normally expect. However, over time, as import and export demand become more elastic, the quantity of imports increases more than the price declines, and/or exports decrease sufficiently for the balance of trade to worsen. In the case of an appreciation we find that the balance of trade follows the path of an inverted J. What we have shown is that the J curve occurs under the same conditions as instability of exchange rates in the short run but stability in the long run. When imports and exports are sufficiently inelastic in the short run, we have both unstable exchange rates and a temporary worsening/improvement of the balance of trade after a currency depreciation/ appreciation, and when the trade balance turns around, stability returns to foreign exchange markets.

  Before leaving the question of the J curve and instability of exchange rates, we should make it clear that foreign exchange markets can be stable even if imports and exports are extremely inelastic. This is because there are numerous other reasons for supplying or demanding a currency. For example, currency speculators might buy a currency during the downward-sloping period of the J curve if they think the currency will eventually move back up again as the trade balance improves. This demand from speculators makes the demand curve for a currency flatter (more elastic) than from considering the demand for the currency only by the buyers of the country’s exports.13

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  eBook - ePub

  Managing the Macroeconomy

  Monetary and Exchange Rate Issues in India

  • Ramkishen S. Rajan, Venkataramana (Rama) Yanamandra(Authors)
  • 2015(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  5 Rupee Movements and India’s Trade Balance: Exploring the Existence of a J-Curve 5.1 Introduction

  According to conventional wisdom, depreciation of a currency should lead to a reduction in imports and give a boost to exports, thereby improving the country’s trade balance. However, the improvement in trade balance may not be immediate. There has been considerable evidence to suggest that there is a lag between the devaluation of a currency and its impact on the trade balance, with an initial worsening of the trade deficit before an improvement. This scenario occurs when imports are priced in foreign currency and exports are priced in domestic currency; prices are sluggish and there are contracts still in place that have been finalised at the earlier exchange rates which prevent quantities from adjusting.1 In this case the only effect of the currency depreciation is to raise the domestic price of imports, hence worsening the trade balance. Over time, as contracts are renegotiated, quantities can start adjusting in response to the exchange rate change. Assuming prices still remain sluggish, currency depreciation should give the country a price competitiveness boost while making foreign goods relatively more expensive compared to import substitutes, thereby improving the trade balance following the initial deterioration. Assuming the elasticity of exports and imports (in absolute terms) is “sufficiently large,” the trade balance should improve compared to its starting point prior to the initial valuation effect-induced deterioration.2

  This pattern of adjustment resembles the letter “J” and hence has been named the “J-Curve” effect. Magee (1973) brought this issue to light in his seminal paper on the deterioration of the US merchandise trade balance of 1971.3

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  Innovative Fiscal Policy and Economic Development in Transition Economies

  • Aleksandr Gevorkyan, Aleksandr V Gevorkyan(Authors)
  • 2013(Publication Date)
  • Routledge

    (Publisher)

  Singh (2004) looks at quarterly data for India between 1975:Q2 and 1996:Q3. This is another example of the J-Curve hypothesis criticism. In fact, the study provides background information on several attempts of J-Curve estimation. The conclusion is that there is no evidence of J-Curve in India. The paper shows no significant relationship of exchange rate fluctuations on the balance of trade. Instead, the final results suggest a combination of the real exchange rate and domestic income having a significant impact on balance trade, while the world income has little role in this. Estimated with application of GARCH procedures, the long-run model exhibits a cointegration relationship among variables, similar to the case study of Brazil presented above.

  Finally, in a recent IMF study, Stucka (2004) carried out an empirical test of the J-Curve effect in Croatia—an example of a small post-socialist to capitalist transition economy—under the two-country assumption. The study produces evidence in support of the J-Curve effect and warns of potential adverse effects of devaluation on overall economy: 1) exchange rate pass-through on inflation; 2) dependence of Croatia’s (as a representative transition economy) export-oriented production capacities on imports of intermediate goods and raw materials, negating potential domestic producer competitiveness by increased import prices in the event of devaluation; 3) price increases of net exports, leading to deterioration of domestic real income; 4) increasing wage gaps between tradable and non-tradable sectors as national production shifts to tradable area; and 5) debt indexation, structure, and cost of debt servicing in the event of currency depreciation must be taken in effect. Overall, the study finds that 1 per cent depreciation leads to a maximum of 1.3 per cent trade balance improvement, while the J-Curve effect results in 2 to 3.3 per cent trade balance deficit deterioration following currency depreciation. As a result, negative effects, including the detrimental impacts on the economy, as mentioned above, of the exchange rate devaluation, overwhelm and do not produce a reliable development tool. In short, this is saying that adjustments achieving “competitive” exchange rate á la Frenkel and Taylor (2006) are inadvisable and are inadequate policy instruments.5

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