Currency depreciation income and the balance of trade
Eventually, domestic households buy fewer imports while foreign households purchase relatively more domestic goods. The next section systemizes these studies into four broad approaches to ease the understanding of the historical improvement of the topic. The Mercantilist approach to international trade assumed that the wealth of a nation depends chiefly on its ability to possess precious metals such as gold and silver. Thus, it is considered as a dynamic view of Marshall-Lerner Condition [ 29 ] or, more generally, the elasticities approach. Marshall-Lerner Condition is a further extension of the elasticities approach.
View at Google Scholar W. The time frame for the J-Curve, before the Marshall-Lerner Condition kicks in and improves the trade balance, is said to be anytime between a few months to two or three years [ 3033 ]. However, in some empirical studies, such an assumption might be invalid. However, the Marshall-Lerner Condition is also indicative of stability. However, this study is chiefly concerned with its effects on international trade.
The next section systemizes these studies into four different reviews and approaches of exchange rate movements on trade balance to ease the understanding of the historical improvement of the topic. However, the Marshall-Lerner Condition is also indicative of stability. The sum of these four categories is also referred to as Domestic Absorption: Some empirical studies argued that excess money supply might increase consumption and lower the trade balance [ 4142 ].
Suppose is constant and the economy is not in full employment currency depreciation income and the balance of trade in developing countries ; when currency devaluation occurs the ultimate effect is expected to be an increase in output, thus a trade balance improvement. However, the Marshall-Lerner Condition is also indicative of stability. Real exchange rate movements affect many economic variables; where some studies covered the relation with foreign direct investment [ 3 ], some other studies focused on the effect on tourism [ 4 ] or, even more generally, on economic growth [ 5 ]. Second, the private sector may not perceive money as net wealth.
First, although the Standard Theory of International Trade provided fertile grounds and gave some basics for the latter approaches, the theory barely discussed the effects of exchange rate on trade balance and merely championed free trade through the principles of Absolute Advantage of Adam Smith and the Comparative Advantage of David Ricardo. The relation can be summarized as follows: By stating these differing definitions of real exchange rate, it should be noted that some studies have discussed the role of nominal exchange rate on trade balance instead of the real exchange rate.
Abstract This paper evaluates the current state of the literature concerning the effects of exchange rate currency depreciation income and the balance of trade on trade balance. However, it is still widely used in many fields of economics for purposes other than trade. Research Method This paper is theoretical in nature and specifically a review article on the determinants effect of exchange rate movement on the trade balance. The time frame for the J-Curve, before the Marshall-Lerner Condition kicks in and improves the trade balance, is said to be anytime between a few months to two or three years [ 3033 ]. Standard Trade Theory relates merchandise with the movements of real exchange rate following a simple common sense approach.
View at Google Scholar S. In summary, if the decline in value of domestic imports is greater than the decline in value of domestic exports, the trade balance will improve. Conversely, if the sum is less than one, trade balance worsens when a depreciation takes place [ 15 ]. Following a currency depreciation, the trade balance is to improve only when the volume effect shown in A and B outweighs the price effect denoted as C.
By considering this fact, we can distinguish a third definition called the real effective exchange rate. Although the Elasticity Approach is commonly known as Bickerdike-Robinson-Metzler Condition [ 17 ], Bickerdike [ 18 ] was actually the one who originally developed and laid the foundations of this approach by modeling nominal import and export prices as functions of import and export quantities [ 1920 ]. By stating these differing definitions of real exchange rate, it should be noted that some studies have discussed the role of nominal exchange rate on trade balance instead of the real exchange rate. It provides a survey of the alternative theories that focus on the effect of exchange rate changes on the trade currency depreciation income and the balance of trade. It systemizes the explanations provided in empirical studies into distinctive theoretical approaches.
The dynamic reaction of trade balance as a short-run dip and long-run recovery takes the shape of the flattened J letter, hence the J-Curve phenomenon. If not, the Marshall-Lerner Condition is not satisfied and the J-Curve is expected to flatten on lower level compared to the level before devaluation [ 32 ]. If currency depreciation income and the balance of trade sum of the two import and export demand elasticities does not exceed unity, the equilibrium is unstable and an economic model with an unstable equilibrium could be inefficient for measuring the outcome of exchange rate depreciation on trade [ 27 ].
Standard Theory of International Trade During the sixteenth to eighteenth centuries, Mercantilism was the dominant economic system of most industrial countries. Data and information are collected through the libraries and recognized journals both local and international. Setting all other variables fixed, a fluctuation in exchange rate affects both the value and volume of trade. Inflationary pressures also undermine the relative price shifts that induce an increase in export production and a decline in consumption of imported goods [ 34 ]. A special focus is given to the J-Curve currency depreciation income and the balance of trade since it is accepted as the most plausible among all and provides indirect methods to test for other approaches [ 7 ].