The Effects of Exchange Rate Change on the Trade Balance in Croatia

IMF Working Papers, April 1, 2004

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A reduced-form model approach was used to estimate the trade balance response to permanent domestic currency depreciation.
Long-run and short-run effects were estimated.
Three modeling methods were employed along with two real effective exchange rate measures.

On average, a 1 percent permanent depreciation improves the equilibrium trade balance by between 0.94 percent and 1.3 percent.
The new equilibrium is established after approximately 2.5 years.
Evidence of the J-curve is found.

Despite the estimated improvement in the trade balance following permanent depreciation, the paper concludes that "it is questionable whether permanent depreciation is desirable to improve the trade balance, taking into account potential adverse effects on the rest of the economy."
Implicit trade-offs to consider include short-run dynamics (J-curve effects), the time required to reach a new equilibrium (approximately 2.5 years), and broader adverse effects on the rest of the economy.

Subject: Depreciation, Exchange rates, Foreign exchange, International trade, National accounts, Prices, Producer price indexes, Real effective exchange rates, Trade balance
Keywords: critical value, Depreciation, exchange rate, Exchange rates, J-curve, J-curve effect, merchandise trade balance, Middle East, producer price index, Producer price indexes, Real effective exchange rates, trade balance, trade balance improvement, trade balance response, transitional economies, version model, WP

The Effects of Exchange Rate Change on the Trade Balance in Croatia — IMF Working Paper No. 2004/065.