The J‐Curve Effect and the U.S. Agricultural Trade Balance

Abstract

According to the J-curve theory, following a currency depreciation, there will be an initial deterioration of the trade balance before an improvement is realized. This paper finds empirical evidence indicating the first segment of the J-curve does exist for the U.S. agricultural trade balance. A 10% depreciation of the U. S. dollar is estimated to lead a deterioration of the agricultural trade balance that will last for about nine months.In the literature on international trade theory, the J-curve phenomenon predicts that, following a currency depreciation, an initial deterioration of the trade balance will occur before an improvement is realized (Krueger, Magee, Junz and Rhomberg). The hypothesized response of the trade balance resembles a J in shape. The J-curve hypothesis is based on a lagged adjustment process. This argument is important because it suggests that the initial impact of a depreciation is negative (i.e., the first segment of the J-curve) and time passes before the positive effects of a depreciation are realized.The policy relevance of linkages among macroeconomic policy, the exchange rate, and V.S. agriculture have been described by Schuh (1974Schuh ( , 1976 and McCalla. We extend this line of inquiry by investigating the relationship between a currency depreciation and the agricultural trade balance. We focus on the characteristics of the short-term response and empirically determine whether or not the agricultural trade balance benefits from a fall in the value of the dollar. The impact of a currency change on both imports and exports is studied whereas most previous work has only considered the linkage between the exchange rate and agricultural exports. . This paper also benefitted from the reviewers' constructive suggestions. A better understanding of the impact of exchange rate changes on the trade balance is especially important in light of the 1985-86 dollar depreciation and the simultaneous agricultural trade balance deterioration. The V.S. dollar plunged in value in early 1985.Within two years it declined by about 45% against the yen, the Swiss franc, and the German mark. Over the same period it fell by approximately 300,lo against the British pound. Despite the fall in the value of the dollar the V.S. agricultural trade balance continued to decline for two years and did not begin to improve until 1987. Figure 1 illustrates the quarterly value of exports and imports of V. S. agricultural products for the 1979-87 period. How much, if any, of the 1985 and 1986 decline in the agricultural trade balance can be attributed to the J-curve effect? The purpose of this paper is to shed some light on this question. The J-Curve EffectThe effects of an exchange rate depreciation on the trade balance are related to the underlying determinants of the demand and supply elasticities of exports and imports. In the short run, production, consumption, inventory, and transaction lags are involved and, consequently, the export supply and import demand elasticities are small (McKinnon, Junz and Rhomberg). Thi...

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