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The J-curve effect describes the time lag with which a currency depreciation or devaluation leads to an improvement in the trade balance. Although the trade balance may improve in the long run, it may worsen initially so that it follows the pattern of a / tilted to the right. The origin of the J-curve is usually attributed to economist Stephen Magee's (1973) attempt to find an explanation for the short-run behavior of the U.S. trade balance in the early 1970s. In 1971 a balance of trade surplus turned into a deficit, and although the U.S. dollar was devalued, the trade balance continued to deteriorate.
The theoretical basis of the J-curve effect is the elasticities approach to the balance of payments. According to this theory a currency devaluation or depreciation is expected to improve the trade balance by changing the relative prices of domestic and foreign goods. By making foreign goods more expensive in the home country and the home country's goods cheaper abroad, demand for imports wUl be low and foreigners will buy more of the home country's exports. Provided that the responses of importers and exporters to the price changes are strong enough, the Marshall-Lerner condition will be fulfilled and the trade balance will improve.
Importance of the J-Curve The J-curve effect is important because it has implications for the effectiveness of policies designed to improve the balance of payments. During the 1 997 financial crisis in Asia, for example, the International Monetary Fund encouraged currency depreciation as part of a package of policies to stabilize the balance of payments of countries hardest hit by the crisis....