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Another View of the J-Curve

Research output: Contribution to Journal/MagazineJournal articlepeer-review

Published
<mark>Journal publication date</mark>04/2007
<mark>Journal</mark>Macroeconomic Dynamics
Issue number2
Volume11
Number of pages22
Pages (from-to)153-174
Publication StatusPublished
Early online date19/03/07
<mark>Original language</mark>English

Abstract

Most of empirical studies find evidence of the J-Curve, but recent results cast doubt over its standard explanation. By addressing the countercyclicality of the current account and its dynamic link with the terms of trade, this paper revisits the J-Curve phenomenon using a two-good dynamic optimizing small open economy model allowing for a habit-forming behavior and capital adjustment costs. While the nonmonotonic adjustment of the current account relies on the degree of habit persistence in consumption and the magnitude of capital installation costs after an unanticipated terms of trade worsening, we show that the sizes of the long-run intertemporal elasticity of substitution under time nonseparable preferences and the import content of real consumption and investment matter as well after a temporary perturbation. As a consequence of an intertemporal speculation effect and an inertia effect, the small country reaches the long-term equilibrium with higher foreign assets after a short-lived terms of trade worsening.