Abstract
The purpose of this paper is to test the existence of the J-curve effect and to show whether the Marshall–Lerner condition holds in the South African manufacturing sector. Using quarterly data from 1995 to 2010, the study uses the vector error correction modelling technique as well as impulse response functions to attain the research objectives. The results show that a long-run equilibrium relationship exists between the manufacturing trade balance and the three explanatory variables: real effective exchange rate, real domestic and foreign income levels. Overall, the results show that a depreciation in the domestic currency results in a deterioration in the manufacturing trade balance in the short run, and that this is followed by an improvement in the long run. The study finds evidence of the existence of the J-curve in the South African manufacturing sector. The long-run dynamics suggest that the Marshall–Lerner condition holds.
Highlights
The collapse of the Bretton Woods system of a fixed exchange rate led to the adoption of a flexible exchange rate regime by many countries, and South African was not an exception
The research question that this paper seeks to address is what are the effects of the real exchange rate of the rand on the South African manufacturing trade balance in the short and long run? This question will be answered by determining the existence of the J-curve effect and showing whether the Marshall–Lerner condition holds in the manufacturing sector
Employing Johansen cointegration, vector error correction model (VECM) and impulse responses, the study finds that the short-run effects of the Real Effective Exchange Rate (REER) on the manufacturing trade balance are different from the long-run effects
Summary
The collapse of the Bretton Woods system of a fixed exchange rate led to the adoption of a flexible exchange rate regime by many countries, and South African was not an exception. There is, a lag period before imports and exports can respond to particular changes arising from the foreign exchange rate market This has implications in the short and long term, giving rise to the J-curve effect and the Marshall–Lerner condition respectively. The research question that this paper seeks to address is what are the effects of the real exchange rate of the rand on the South African manufacturing trade balance in the short and long run? This question will be answered by determining the existence of the J-curve effect and showing whether the Marshall–Lerner condition holds in the manufacturing sector This will shed light on whether a mechanism of weakening the domestic currency would result in an improvement in the manufacturing trade balance.
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