The J-Curve: Understanding the Relationship Between Currency Devaluation and Trade
What is the J-Curve and how does it relate to currency devaluation?
The J-Curve illustrates the complex relationship between currency devaluation and a country’s trade balance. Initially, devaluation may lead to a worsening trade deficit as the immediate impact on import prices takes effect. However, over time, exports increase and imports decrease, forming the characteristic ‘J’ shape. |
Why does the trade balance initially deteriorate after currency devaluation?
Import contracts are often signed in advance, leading to immediate increases in import costs when denominated in domestic currency. On the other hand, exports typically react with a lag due to production and trade delays. |
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What are the conditions for the J-Curve to be effective in the long run?
According to the Marshall-Lerner condition, for devaluation to improve the trade balance, the sum of the elasticities of exports and imports must be greater than 1. Otherwise, the long-term impact on the trade balance may not be significant. |
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