The J-Curve

When writing about yesterday’s class, I forgot to mention that we also talked about the J-Curve. This curve explains the lags that exist between changes in exchange rates and changes in net exports. It’s J-shaped because net exports will first see a decrease as importers scurry to adjust their numbers, once the real exchange rate has dropped. But then once all the imports have been adjusted, the gross exports will start to increase, pushing up net exports along with it.

Here is an excellent description from the New York Fed of the J-Curve:

The J-Curve

Prof. Menzie Chinn of UW, Madison (and of the economics blog, Econbrowser) questions the empirical validity of the J-Curve, though. The evidence on the short-term decrease in net exports is questionable, he says. Here’s what he writes:

I don’t disagree with the notion that there are lags in adjustment… . And indeed the “J-curve” is well ensconced in international finance/open economy macro textbooks. But I want to observe that the empirical evidence on the J-curve — the proposition that the trade balance worsens immediately after an exchange rate depreciation as the valuation effect overwhelms the quantity effects, especially in the short term — is mixed. [link]

Finally, here is a graph showing the relationship between Exports as a fraction of GDP, and a Trade-Weighted Exchange Rate Index, from 1973 to 2007. (It’s an updated version of the graph that’s in your text books.)

Exports and Real Exchange Rate vs. Time

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