Trade Deficit And Currency Devaluation: Testing The J-Curve

Abstract

This paper is testing empirically the effect of a devaluation of a currency on the trade account of the country, the J-curve effect, by using the trade between the U.S. and seven countries (Euro-zone, Mexico, Canada, United Kingdom, Switzerland, Japan, and Australia). A devaluation (depreciation) of the U.S. dollar is increasing the spot exchange rate ($/FC) and increases the price of imports and reduces the price of exports. Then, imports are falling and exports are increasing and the trade account is improved in the long-run. In the short-run, the trade account is deteriorated because the international trade transactions are pre-arranged and the invoices are in foreign currency, so it cannot be adjusted. This J-curve hypothesis is tested by using a regression equation and a VAR model, where the volatility of the real exchange rate (TOT) is specified with a GARCH-M process. Also, different stationary tests are taking place, like, unit root and cointegration ones. The empirical results mostly are supporting the J-curve effect.