J curve

The J- curve or the J-curve effect is an economic theory hypothesis, which describes the time course of the effects of a real depreciation of the domestic currency on the foreign balance of a country in an open economy. In the short term, the effect on the current account is negative (import value > export value ); only over time performs a real depreciation of the domestic currency to the desired improvement in the current account balance. The curve gets its name from its resemblance to the letter J.

Normal reaction of the current account

A devaluation of the domestic currency leads ceteris paribus to an improvement of the current account:

• Through a devaluation of the domestic currency, the real exchange rate rises ( in the quotation ).
• Domestic goods and services become relatively cheaper.
• The aggregate demand for domestic goods and services rises.
• Domestic goods and services are increasingly in demand abroad.
• It is longer exported.
• Imports decrease, since nationals substitute foreign products and services by domestic products and services.
• Net exports increases, the current account improves.

An appreciation, however, leads to a deterioration of the current account balance. This reaction of the current account is called normal reaction of the current account balance. It is assumed here that the Marshall - Lerner condition is fulfilled and a sufficiently large elasticity of demand is given.

Lags of the exchange rate

The improvement above the current account following a devaluation of the domestic currency can only be obtained in the framework of a static- comparative analysis. In this case, the equilibrium condition in the goods market before and after an exchange rate change is compared. The transition from the old to the new equilibrium is here disregarded. It may happen, however, that worsens immediately after a devaluation, the current account balance. In such a case, a positive change can be observed after several months. The graphical evolution of current account - only worse becoming, before improving - has a great resemblance to the trace of the letter J ( see figure below ).

Reasons for the time delay

The prices and quantities of foreign trade transactions are determined mostly months in advance. The export business in the domestic and imports in foreign currency are made.

If a devaluation of the domestic currency, are obtained for the export transactions in the domestic currency in the short term, no changes. Due to the devaluation, however, increases the exchange rate. For a unit domestic currency you get fewer units of foreign currency. Imports are now relatively more expensive, that is for the pre-specified imports more domestic monetary units must now be paid. The increase in import expenditure due to higher relative prices, also called price effects, resulting in a deterioration of the trade balance and thus to a deterioration of the current account balance.

It is clear, therefore, that a devaluation in the short term though ( in foreign currency ) influences the prices of goods, but not the export and import volumes. An adjustment of the trade quantities are much slower. Only when new export and import contracts are concluded, there is a lot of reaction. Due to the rise in the exchange rate

• Have become cheaper, the domestically produced goods for foreign customers. The demand for domestic goods and thus exports increase abroad.
• Have become relatively more expensive goods manufactured abroad. Earlier domestic customers import less and substitute instead by foreign domestic goods.

Over time, the exports and imports rise and fall. Finally, if the Marshall - Lerner condition is satisfied and the positive effects on the trade balance outweigh the negatives, the current account improved beyond the original value.

Immediately after a currency devaluation, the current account deteriorates ( point A to point B). Only once have adapted to the new exchange rate, import and export volumes, the current account improves ( point B to point C). After the time is exceeded by point C, the current account has improved over the ruling before the devaluation level addition.

Empirical Relevance

Empirically can the J- curve effect, especially for foreign trade goods with price-elastic demand evidence. For goods whose demand does not or hardly reacts to price changes due to devaluation of a negative reaction of the foreign trade balance is observed. An example is crude oil whose import quantity depends only to a relatively small degree of its price.

Since, however, these exceptions in the latter goods, Blanchard and Illing come to the following conclusion: " In general, let econometric analyzes [ ... ] to the conclusion that a real depreciation in all OECD countries will ultimately lead to an improvement in the trade balance. However, they also show that this process takes a while, generally between six months and one year. "

Practical Relevance

A proof for the practical relevance of the J-curve effect represent the U.S. net exports dar. in the period 1984-1991

At the beginning of the 80s there was in the U.S. to a strong appreciation of the dollar and a rapidly deteriorating current account balance. Although from 1985 to 1986 was a rapid devaluation of the dollar and thus a rapid course of deterioration, the current account deteriorated further. Only in 1987 it finally came to the hoped-for improvement. In the picture can be seen clearly is the similarity of net exports over time with the letter J.

Walking stick effect

So far, only the effects of a devaluation of the domestic currency were considered. In the event of a revaluation, the J- curve effect can be reversed: This first shows an improvement in the current account and in the course of further adjustment finally if a deterioration. This inverted J - curve effect is also referred to as a " walking stick " effect.