Essay About Exchange Rate And Important Considerations

Exchange Rate and Trade Balance
The management of the Exchange Rate has been a critical issue for the economic policy,
especially in developing countries. In defining an exchange rate policy, one of the most
important considerations is the responsiveness of Trade Balance (TB) to changes in terms
of trade or, more generally, in Real Exchange Rate (RER). The effects of currency
depreciation on a countrys trade balance have centred an important and on-going debate
in the international economic literature. Precisely, this issue has been traditionally studied
in the Marshall-Lerner condition (ML) and the so called J-curve framework. According
to the ML condition, currency devaluation improves the trade balance in the long run
only if the sum of the absolute values of imports and exports demand price elasticities
exceeds unit. However, due to the lag dynamics structure, TB can worsen in the short-run
because of the inelastic demand for imports and exports in the immediate aftermath of an
exchange rate change. In this case, TB is said to follow the J-curve pattern.
A wide number of papers have tested the ML condition and J-curve. Bahamani-
Oskooee and Ratha (2004) is a good survey on ML and J-curve showing non conclusive
results on this issue. In Bahamani-Oskooee and Niroomand (1998) the ML condition is
addressed for almost thirty developed and developing countries over the period 1960-92.
Gomes and Paz (2005) and Tsen (2006) demonstrate the existence of a long run
relationship among TB, real exchange rate, foreign and domestic income for Brazil in the
nineties and for Malaysia during 1965-2002 respectively. Mahmud et al. (2004) suggest
that, though during fixed exchange rates periods ML condition is supported, it is less
probable in flexible exchange periods. Almost all these papers find support for the
existence of the J-curve pattern except Narayan (2004) who does not confirm the ML
condition in New Zealand.
As far as we know, there is only one paper that deals with ML condition