Presentation on theme: "Episodes of the J Curve Episodes of the J-curve Supplementary slides in International Macroeconomics & Finance Jarir Ajluni - July 2005."— Presentation transcript:
Episodes of the J Curve Episodes of the J-curve Supplementary slides in International Macroeconomics & Finance Jarir Ajluni - July 2005
Episodes of the J Curve 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. TB Time 0 + _ t
Episodes of the J Curve 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 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 The UK Episode of 1967 £/$ Depreciation in Q3 1967Trade Balance worsened in the first qtr Data Source: IMF International Financial Statistics (IFS), obtained from ESDS International Services
Episodes of the J Curve Korea’s Episode of 1997 WON/$ Depreciation in Q4 1996Trade Balance worsened in the first qtr Data Source: IMF International Financial Statistics (IFS), obtained from ESDS International Services
Episodes of the J Curve Jordan’s Episode of 1988 JD/$ Depreciation in Q Trade Balance remained chronically negative but improved after 2 qrts Data Source: IMF International Financial Statistics (IFS), obtained from ESDS International Services
Episodes of the J Curve J curve: A Structuralist view The economy consists of two groups: ‘Wage-takers’ & ‘Capitalists’ Two kinds of Goods & Services: ‘Traded’ and ‘Non- Traded’. 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. Structure of the international Trade of a Small Open Economy Both Capitalists, Wage-takers are the importers of traded goods, however the exporters consists of Capitalists only.
Episodes of the J Curve J curve: A Structuralist view 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. Effects of a J-curve scenario J curve suggest depreciation increase imports in the short instance then boosts the exports. 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. 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. Welfare effects: The depreciation increase income inequality, boosts exports but doesn't reduce poverty.
Episodes of the J Curve 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 References I.Krugman, Paul. (1991), “Has the Adjustment Process Worked?” Policy analyses in International Economics, 34, Institute for International Economics. II.Hallwood, P and MacDonald, R. (2000) “ International Money and Finance”, 3 rd edition