Trade ows are ²xed in the short run er pass through

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trade ±ows are ²xed in the short run ° ER pass-through: nominal exchange rate changes may cause less than proportional changes in the RER in the short-run 15
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J-curve ° It is sometimes observed that CA worsens immediately after real depreciation, but improves only some months later. ° The adjustment dynamics are reminiscent of a J, therefore a J-curve. ° If the volume of imports and exports is ²xed in the short run (through contracts, etc.), a depreciation of the domestic currency will not a/ect the volume of imports or exports. ° But it will increase the value of pre-contracted imports in domestic currency and therefore decrease the CA . ° The value of exports in domestic currency does not change. ° The current account could immediately decrease after a currency depreciation, then increase gradually as the volume e/ect begins to dominate the value e/ect. 16
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J-curve ° In the data, for most industrial countries, the J-curve lasts more than 6 months, but less than a year. Thus point 3 is typically reached within a year of the real depreciation, and the CA continues to improves after that. 17
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J-curve ° Modify our previous analysis: M s " can depress Y initially by depreciating home currency. But now it may take some time for " M s leads to an improved CA and therefore in higher aggregate demand. ° If M s " depresses Y; then domestic R would have to fall further to clear the money market ° E will overshoot _____ sharply. So, J-curve e/ects would _____ the volatility of ERs. 18
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Exchange rate pass-through ° Pass through from the exchange rate to import prices measures the percentage by which import prices change when the value of the domestic currency changes by 1%. ° In the DD ² AA model, the pass through rate is 100%: RER depreciation exactly matches a depreciation of the domestic currency. ° In reality, pass through may be less than 100% due to price discrimination in di/erent countries. ° Firms that set prices may decide not to match changes in the exchange rate with changes in prices of foreign products denominated in domestic currency. ° Firms may wait to ²nd out if the currency movements re±ect a de²nite trend before making price and production commitments that are costly to undo. 19
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Exchange rate pass-through ° If prices of foreign products in domestic currency do not change much because of a pass through rate less than 100%, then the ° value of imports will not rise much after a domestic currency depreciation, and the current account will not fall much, making the J-curve e/ect smaller. ° volume of imports and exports will not adjust much over time since domestic currency prices do not change much. ° Pass through of less than 100% dampens the e/ect of depreciation or appreciation on the current account. 20
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