IV. Macroeconomic activity in a global economy

B. International investment

3. Open-economy macroeconomics

d. The J-Curve
    "Perverse" effects of exchange rate changes

    ? Whenever OPEC raises its oil prices, is that real depreciation or real appreciation for them?

    ? So, what should happen to their CAB?

    This is the opposite of what actually does happen

    So, what's wrong with our analysis so far?

    --Lesson of this section: exchange rate changes can have current-account effects that are contrary to what we generally expect, especially in the very short run.

    Analytical question: what makes this happen? Sufficiently inelastic demands for tradables

    See J-Curve worksheet

Intuition:
    NX$ = X$ - M$

    1% of real depreciation => imports 1% more expensive
    --Bad news for trade balance
    --For trade balance to rise, trade volumes must offset this price effect

    Ex.1: Qx rises > 1%
    Ex.2: Qm falls > 1%
    Ex.3: Any combination of 1 and 2 which adds up to > 1%.

    Usually met, especially in long run. But not always so as mentioned abouve.

    Note: if either elasticity > 1 we're O.K.
    Example: For OPEC: can't determine the effect of an ER chagne by looking only at the elasticity of demand for OPEC oil. Need to know OPEC elasticity of demand for imports too. Their short-run demand for our goods rose only a little with their new-found wealth.

    Result: -R --> +NX only if:

    |%DQx| + |%DQm| > |%DR|

    => |%DQx/%DR| + |%DQm/%DR| > 1

    => foreX + domeM > 1

   See: Devaluation case studies handout

    Return to example of expansionary MP
    ? In foreign-sector diagram, how does NX look when we have a J-curve?

Growth of money supply R NX ($billion) a. 1991 4.8% 86.5 -29 b. 1992 11.4% 83.4 -39       Note: As elasticities rise over time, the situation reverses and the trade balance rises.

    EX: UK: LR elasticities:
    eX by ROW = 0.48 / eM by UK = 0.65
    eX + eM = 0.48 + 0.65 = 1.13, but lower in short run

Note: Contractionary depreciation is possible:
+MP --> -r -->	+I --> +Y
	-R --> -NX --> -Y

    Note3: Depreciation with J-curve => K-inflows occur despite our lower interest rate
    Why? Super appreciation anticipated
    Essentially, J-curve = a special case of overshooting

    How long is long?
    Old wisdom: 6-9 months
    New claim: elasticity = 50% of long-run elasticity after 2 years, 90% after 5 years