Page 226 - DECO503_INTERNATIONAL_TRADE_AND_FINANCE_ENGLISH

International Trade and Finance

Notes The reason is that the existing export-imports deals cannot be reversed. Importers will have to import
at post-devaluation higher prices, causing a high import bill. The result is deterioration in the BOP.
In the long run, however, imports begin to decline and exports pick up at post-devaluation prices.
Consequently, the deterioration in the trade balance is halted and over time BOP begins to improve.
When the overall trend is plotted on a graph paper, it produces a J-shape curve, as shown in Fig. 19.7.
The economists call it J-curve effect of devaluation.

J-Curve

Trade Balance O T 0 T 1 T 2 Time

Figure 19.7: The J-Curve Effect
In Fig. 19.7, vertical axis measures balance of trade (X – M) and horizontal axis measure ‘time’. Point
T marks the time of devaluation. As the figure shows, the balance of trade deteriorates immediately
0
after devaluation, i.e., during the period from T to T . It begins to improve after time T and deficit
0 1 1
begins to decrease. It is only after some time, say time T , that devaluation becomes effective and
2
balance of payment goes into surplus. The duration of period between point T and T varies from
2
0
country to country.
Self-Assessment
1. Choose the correct options:
(i) If a nation's balance on current account is positive and it has neither a deficit nor surplus in
its overall balance of payments:
(a) its imports exceed its exports
(b) foreign purchases of its assets exceed its purchases of assets abroad
(c) it has a trade deficit
(d) it has a capital and financial account deficit
(ii) Suppose the exchange rate is currently $1 = 6 Norwegian kroner. If a Big Mac costs $2.50 in
the U.S. and there is purchasing power parity, the price of a Big Mac in Oslo is:
(a) 40 kroner (b) 25 kroner
(c) 15 kroner (d) 12.5 kroner
(iii) A purchase of foreign reserves by a country's Central Bank would be reflected as:
(a) An entry in a separate account off the balance of payments.
(b) A credit in the financial account and a debit in the financial account.
(c) A credit in the current account and a debit in the financial account.
(d) A debit in the current account and a credit in the financial account.
(iv) What does the term "balance of payments deficit" refer to?
(a) A negative statistical discrepancy.
(b) A positive statistical discrepancy.
(c) A decline in official international reserves.
(d) An increase in official international reserves.

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