On Pg 235 of Book 5, in describing the J-Curve, the book states that: “In the short run, if a country’s currency depreciates in real terms, the cost of imports increases, causing a widening in the trade balance (exports - imports) and an increase in domestic inflation.”
But will it always cause a widening in the trade balance? For example, if the country is a net importer and therefore has a negative trade balance (by the Exp - Imp equation), wouldn’t rising costs of imports limit the country’s import activity and therefore close their trade balance gap? Am I missing a key element here, or is Schweser being overly simplistic and assuming an initially even trade balance?
In the short-run, imports will become more expensive as your currency depreciates. Businesses do not immediately stop importing and cancelling orders because of a depreciation. In fact, they may not even be able to. But in the long-run, businesses reduce their imports in response to a depreciation, thus improving/restoring the trade balance. Meanwhile, exporters will benefit to increased orders.
Thanks, that makes sense. By that same logic then, a net exporting country would see their trade balance narrowing in the short run when their currency depreciates due to the rising cost of importing (Same amount of exports - same amount of more expensive imports), which will correct in the long run. I hate when Schweser makes general statements like that which aren’t always true…