Abstract
This paper examines the relationship between exchange rate and trade balance in determining whether the J-Curve phenomenon holds in the short and long-run for Sierra Leone during the period 2002Q2-2019Q4. The econometric technique commenced with an assessment of unit root to ascertain the order of Unit Root and followed by an Unrestricted Vector Autoregressive (VAR) estimation. The procedure leading to using Vector Error Correction Model (VECM) was confirmed through Johansen Cointegration test. The result suggests long-run relationship running between exchange rate and trade balance for all three model equations, but weakly for the Trade Balance Model, which is also attested in the impulse response shock for trade balance and real effective exchange rate. The Marshall-Lerner (ML) condition was also satisfied, with the joint elasticity for Export and Import summing up to more than one. The short-run dynamic situation for Sierra Leone was not satisfied with the Wald Tests for all three models—this could be due to internal macroeconomic bottlenecks associated with weaknesses in the real sector. The findings for this study are relevant for Central Bank policy formulation and fiscal consolidation efforts. It is highly recommended that domestic production is boosted to ascertain macroeconomic stability in the economy.
Highlights
J-Curve effect is modelled on the assumption that a country’s trade balance initially worsens following a devaluation of its currency exchange rate—there is a possibility of recovery with an outcome that surpasses its previous performance (Rose & Yellen, 1989)
Data Utilization and Description In order to empirically determine the twin effect of the J-Curve effect and Marshall-Lerner condition in Sierra Leone, the researchers have produced variables in their logarithmic form, sourced from the Bank of Sierra Leone dataware house and Balance of Payment Section in the Research Department—these include the following: Trade Balance (TB), Real Effective Exchange Rate (REER), Broad Money (M2) and Foreign Income (Fy)”, with data ranging from 2002Q2-2019Q4 as exemplified in Figures 4-10 below
Our justification for utilising the identified variables is based on their relative importance to the long-term stability of the Sierra Leone economy, in assessing theoretical approaches connected with Absorption, Monetary and Elasticity concepts of both the J-Curve phenomenon and the Marshall-Lerner condition
Summary
J-Curve effect is modelled on the assumption that a country’s trade balance initially worsens following a devaluation of its currency exchange rate—there is a possibility of recovery with an outcome that surpasses its previous performance (Rose & Yellen, 1989). Plethora of studies have been pursued in ascertaining the reality of J-Curve and Marshall-Lerner condition in a bid to determine relationship between a country’s exchange rate and trade balance, with some notable highlights for the Sierra Leone economy (Lerner, 1944; Bangura et al, 2013; Adeniyi et al, 2011) Critical to such pursued efforts, stability in a country’s exchange rate is very important in determining currency valuation, in building favourable terms of trade, which is essential for maintaining stable macroeconomic condition (Bangura et al, 2013).
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