The devaluation of a country’s currency is likely to have which of the following effects on the country’s balance of trade over time? a. A positive effect in the short run and a negative effect in the long run. b. A negative effect in the short run and a positive effect in the long run. c. A positive effect in the short run and a positive effect in the long run.
a. A positive effect in the short run and a negative effect in the long run. Net exports will exceed net imports. This imbalance will not be good in the long run.
I thought the answer would be b due to the J-curve effect. Initially, imports would cost more which would add to the trade deficit, but in the long run exports would increase to the point of exceeding imports reducing any trade deficit. Best, TheChad
B due to J-Curve effect.
B because of J curve.
I thought the answer was c), I thought devaluation would make imports more expensive and exports cheaper resulting in a current a/c surplus. Moreover it becomes cheaper for foreigners to invest in a country that has devalued its currency resulting in a capital a/c surplus. My question is: Do these gains ever reverse in the long run? I didn’t think so, can someone explain how c) is not the answer?
B is correct. A currency’s devaluation will immediately make import prices more expensive. However, there is no immediate fall in the demand for those imports. Therefore, in the short run, devaluation will worsen the balance of trade, and the benefits of devaluation should eventually occur in the long run. This is called the “J-curve” effect. A is incorrect. The balance of trade would improve in the long run, but not in the short run because consumers may not immediately respond to the change in higher import prices. C is incorrect. The improvement in the balance of trade because of currency devaluation occurs in the short run rather than the long run. ----- grrr… I see the LOS for this now. 4.19e in the Foreign Exchange Parity Relations section, but Stalla Passmaster put this question in 4.17: Exchange Rate and the Balance of Payments. Thanks guys -
This is a good example of where CFA theory does not align itself with the real world. Take the depreciation of USD over the first half of 2008. As dollar fell relative to most other currencies, the US exports significantly picked up (expecially engineering and industrial products to Asia and Europe, e.g. planes and engines) and the US trade balance improved to the point it was about the only component of the US GDP that was positive. US imports increased in the same period but not to the same degree - the imports were falling due to lower crude oil demand. So much for the J-curve.
The answer is B due to J curve effect.