Page 75 - Azerbaijan State University of Economics

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

currency, manat, was steadily appreciating during the late 2000s while

oil-dominated exports were rising at the same time. For this very reason
only the non-oil segment of the country’s total exports will be examined,

since the oil component, which puts pressure on the domestic currency to
appreciate, would have an exactly opposite, or inverse, relationship with

the exchange rate. Overall, establishing a relationship between the

Azerbaijani trade balance and the manat would carry practical
significance for the nation’s conduct of monetary policy, as well as shed

light on the peculiar events of the past half-decade.
The focus of this paper is to establish a connection between the trade

dynamics of Azerbaijan with the Euro zone (Euro-17) during the 2006:01-

2009:12 time interval. The expectation is that there exists a long-run
relationship between the trade balance of Azerbaijan, which is represented

as the difference between the Azerbaijani exports to the Euro zone and the
imports from the Euro zone, and the real bilateral exchange rate (RFX). A

traditional trade balance model will be estimated with two equations, for
exports and for imports, via the Johansen approach and a Vector Error

Correction Model (VECM). Preliminary unit-root tests will be performed,

and the results will be presented. The co integration equations will present
the long-run relationship between exports, imports, and the exchange rate.

It is expected, for the Marshall-Lerner condition to hold, that the sum of
export and import elasticity’s from these two equations will exceed 1. In

the end, an Impulse Response Function (IRF) will show the short-run
movement of the trade balance in response to the exchange rate

innovations, yielding a J-curve demonstration.

The remainder of the paper is organized as follows. Section 2
describes the data used in the study. Section 3 presents the model and

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