What Is a J Curve?

The J Curve is an economic theory which states that, under certain assumptions, a country's trade deficit will initially worsen after the depreciation of its currency—mainly because higher prices on imports will be greater than the reduced volume of imports.

The J Curve operates under the theory that the trading volumes of imports and exports first only experience microeconomic changes. But as time progresses, export levels begin to dramatically increase, due to their more attractive prices to foreign buyers. Simultaneously, domestic consumers purchase less imported products, due to their higher costs.

These parallel actions ultimately shift the trade balance, to present an increased surplus and smaller deficit, compared to those figures before the devaluation. Naturally, the same economic rationale applies to the opposite scenarios, where a country experiences a currency appreciation, which would consequently result in an inverted J Curve.

A Deeper Look at the J Curve Theory

There is a lag between the devaluation and the response on the curve. Mainly, this delay is due to the effect that even after a nation’s currency experiences a depreciation, the total value of imports will likely increase. However, the country's exports remain static until the pre-existing trade contracts play out. Over the long haul, large numbers of foreign consumers may bump up their purchases of products which come into their country from the nation with the devalued currency. These products now become cheaper relative to domestically-produced products.

Key Takeaways

  • The J Curve is an economic theory that says the trade deficit will initially worsen after currency depreciation.
  • Then the response to the curve, which is to an increase in imports as exports remain static, is a rebound, forming a “J” shape.
  • The J Curve theory can be applied to other areas besides trade deficits, including in private equity, the medical field, and politics.  

Where the J Curve May Be Applied

The J Curve concept is a tool utilized across multiple disciplines. In private equity circles, J Curves demonstrate how private equity funds historically usher in negative returns in their initial post-launch years but then start witnessing gains after they find their footing. Private equity funds may take early losses because investment costs and management fees initially absorb money. But as funds mature, they begin to manifest previously unrealized gains, through events such as mergers and acquisitions (M&A), initial public offerings (IPOs), and leveraged recapitalizations.

In medical circles, J Curves appear in graphs, where the X-axis measures either one of two possible treatable conditions, such as cholesterol levels or blood pressure, while the Y-axis indicated the likelihood of a patient developing cardiovascular disease.

Finally, in political science, the noted American sociologist, James Chowning Davies, incorporated the J Curve in models used to explain political revolutions, where he asserts that riots are a subjective response to a sudden reversal in fortunes after a long period of economic growth, known as relative deprivation.

Real World Example

Look no further than Japan in 2013 for a practical example of the J Curve. This example illustrates how the trade balance deteriorated after a sudden depreciation in the yen, owing mostly to the fact the volume of exports and imports took time to respond to price signals.

In 2013 the USD to yen exchange rate hit 100—the first time since 2009—and has remained above that level ever since.

Japan’s government made major purchases of its currency to help get out of a deflationary state. Japan’s trade deficit swelled to a record 1.63 trillion yen (US$17.4 billion) on energy imports and a weaker yen.