DEFINITION of 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 due to the fact that higher prices on foreign 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 micro changes. But as time progresses, export levels begin to dramatically increase, due to their more attractive prices to foreign buyers, while domestic consumers contrarily purchase less imported products, due to their greater 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 is applicable to the opposite scenarios, where a country experiences a currency appreciation, which would consequently result in an inverted J Curve.
A Deeper Look
So why is there a time lag, for the J Curve to present itself? Mainly because even after a nation’s currency experiences a devaluation in or a depreciation, the total value of imports will likely increase, however exports remain static, until the pre-existing trade contracts play out. But over the long haul, large numbers of foreign consumers may bump up their purchases of products exported into their country, which are cheaper, relative their own domestically-produced products.
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. Granularly speaking: private equity funds may take early losses because money is initially absorbed by investment costs and management fees. But as funds mature, they begin to manifest previously unrealized gains, through events such as mergers and acquisitions, initial public offerings and leveraged recapitalizations.
In medical circles, J Curves are used 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.
And 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 revolutions are a subjective response to a sudden reversal in fortunes after a long period of economic growth, known as “relative deprivation”.