Episodes of the J-curve

1. Supplementary slides in International Macroeconomics & Finance Episodes of the J-curve Jarir Ajluni - July 2005 Episodes of the J Curve

2. TB + t 0 Time _ J Curve Definition The j-curve is an incident where the Trade Balance would actually be worsened following domestic currency devaluation (Exchange rate depreciation), the elasticity approach ignores time, as the exchange rate increases this would not boost exports instantaneously, because the switching mechanism takes time to occur, while price inelastic home demand of imports would increase value of imports instantly, this would worsen the TB in the short-run until the increased competitiveness of exports is realised in the longer horizon and the TB is improved, the TB values over time takes a shape of letter J as in the Figure. Episodes of the J Curve

3. J Curve Episodes Episodes of the J Curve are numerous, but are a consequences of different reasons, the following slides shows episodes from industrialised economy with well functioning financial markets, and from an emerging market with imperfections in the financial markets and lastly episode from a tiny economy with high government interference and corruption. First the J curve episode of the US during the mid 1980s is exhibited as often quoted in the literature as ‘interesting’, in the 2nd example, the case of the UK; the incident of the J curve is a text-book classic example of currency devaluation, the next example is derived from Korean data during the Asian crisis where the lack of trust of foreigners in the banking and financial sector lead to a capital flight and excessive devaluation that lead to a significant rise in the value of imports in the first instance leading to a trade balance exhibiting a J curve, lastly it is worthwhile to consider a case of the tiny small open economy like Jordan where sudden devaluation was exploited by the informed Gov. officials on the expense of ill-informed public that lead to further devaluation and showing a J curve behaviour in the trade balance. Episodes of the J Curve

4. The US Episode of 1985 Depreciation of the dollar early 1985 Trade Balance worsened then improved Data Source: IMF International Financial Statistics (IFS), obtained from ESDS International Services Episodes of the J Curve

5. The UK Episode of 1967 £/$ Depreciation in Q3 1967 Trade Balance worsened in the first qtr Data Source: IMF International Financial Statistics (IFS), obtained from ESDS International Services Episodes of the J Curve

6. Korea’s Episode of 1997 WON/$ Depreciation in Q4 1996 Trade Balance worsened in the first qtr Data Source: IMF International Financial Statistics (IFS), obtained from ESDS International Services Episodes of the J Curve

7. Jordan’s Episode of 1988 Trade Balance remained chronically negative but improved after 2 qrts JD/$ Depreciation in Q4 1998 Data Source: IMF International Financial Statistics (IFS), obtained from ESDS International Services Episodes of the J Curve

8. J curve: A Structuralist view Structure of the international Trade of a Small Open Economy The economy consists of two groups: ‘Wage-takers’ & ‘Capitalists’ Two kinds of Goods & Services: ‘Traded’ and ‘Non- Traded’. Both Capitalists, Wage-takers are the importers of traded goods, however the exporters consists of Capitalists only. Large proportion of imported Traded goods have a price inelastic demand as it is often serves as irreplaceable consumption goods and inputs of production for domestic non-traded goods. Episodes of the J Curve

9. J curve: A Structuralist view Effects of a J-curve scenario J curve suggest depreciation increase imports in the short instance then boosts the exports. Devaluation leads to domestic inflation harming the Wage-takers & Capitalists this inflation is high enough to affects wage-takers in a long unspecified term but affects Capitalists exports adversely only in the short run. Effects on imports: devaluation increase the cost of buying irreplaceable goods, lack of capacity for the expenditure switching effect would chronically worsen the trade balance and cause domestic inflation. The inflation is not high enough to offset the devaluation effects, exports boost because of the exchange rate depreciation increasing the Capitalists revenues from exporting. Welfare effects: The depreciation increase income inequality, boosts exports but doesn't reduce poverty. Episodes of the J Curve

10. Concluding Remarks Other reasons for the J curve of the US, Krugman (1991):- • “Other things” were not “Constant”. • Exporters were pricing to market delaying the adjustment. Given the J curve phenomena then Does the traditional expenditure switching adjustment mechanism work? According to Krugman (1991) the answer is YES the adjustment does work & work well but only after a lag. Episodes of the J Curve

11. Krugman, Paul. (1991), “Has the Adjustment Process Worked?” Policy analyses in International Economics, 34, Institute for International Economics. • Hallwood, P and MacDonald, R. (2000) “ International Money and Finance”, 3rd edition References Episodes of the J Curve