Page 71 - Azerbaijan State University of Economics

J-CURVE AND THE MARSHALL-LERNER CONDITION - THE CASE OF AZERBAIJAN

and volume effect. The price effect implies that currency depreciation

will cause imports to be more expensive and exports to appear cheaper in
the short run for the domestic buyers. The balance of trade may

deteriorate in the short run due to the time required for the exports and
imports to adjust to the new exchange rate. Krueger (1983) has claimed

that there are certain goods which have already been purchased or

ordered at the time of the devaluation, and the short run is dominated by
the completion of old contractual obligations. As the volume of trade

begins to respond to the depreciation, it is believed that the so-called
“volume effect” of currency devaluation will reverse the trade balance

movement and eventually improve it. Dornbusch and Krugman (1976)

argued that there would be a perverse negative response of the trade
balance to currency depreciation, followed by larger export elasticity that

would improve the balance in the long run. The phenomenon of the
domination of the volume effect over the price effect in the long run is

the Marshall-Lerner condition. If plotted over time, the trade response
graph yields a J-resembling line, thus the J-curve terminology.

The impact of currency devaluation on the trade balance (J-curve

phenomenon) has been investigated by many researchers by using
different econometric techniques and models. Most of the earlier studies

used aggregate data, while recent studies have employed bilateral trade
data. The use of aggregate data suppresses the actual movements of

those variables involved. This is the main reason for moving to bilateral
data. The empirical results of these studies are mixed. For instance, some

studies have found no evidence for the J-curve effect (Narayan 2006;

Bhamani-Oskooee and Wang 2006). Others have found that trade
balance is improved in the long run (Bahmani-Oskooe and Ratha 2004;

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