Real Exchange Rates and the Balance of Trade: Does the J-curve Effect Really Hold?

Abstract

In this paper, we re-examine the relationship between trade flows, real effective exchange rates, and incomes by using the bilateral trade flows of 33 countries that form more than two-thirds of total world trade. For each country, we consider the bilateral trade flows of the country under consideration vis-a-vis all other countries. The analysis reveals the fact that for most of the countries, a real depreciation of the home currency has favorable effects on the home country's trade balance in the long run. This long-run effect manifests itself in the short run for a small number of countries, indicating the fact that satisfying the Marshall-Lerner condition in the short run is more difficult. However, there is no evidence for the J-curve phenomenon, which suggests an initial deterioration in the trade balance in the short run following a depreciation.