A disaggregated approach to test the J-Curve phenomenon: Japan versus her major trading partners

What is it about?

A limited number of studies have tested the J-Curve phenomenon using bilateral trade data between the United States and its major trading partners. In this paper, we test the J-Curve hypothesis by using quarterly bilateral data over the 1973-98 period between Japan and its nine major trading partners. We demonstrate that when aggregate data are used, there is no evidence of the J-Curve in the short run or any significant relation between trade balance and effective exchange rate in the long run. However, when bilateral data are employed, we find evidence of the J-Curve between Japan and Germany as well as between Japan and Italy. We also find that real depreciation of the yen has favorable long-run effects in the cases of Canada, the United Kingdom, and the United States.

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Why is it important?

Since introduction of the J-Curve phenomenon into the literature, most studies have estimated a reduced form trade balance model to establish the empirical validity of the phenomenon. Recent studies, however, have emphasized the use of bilateral rather than aggregate data. A limited number of studies have examined the bilateral trade and exchange rate data between the United States and her six large (developed) trading partners. The findings have been mixed. While no specific short-run pattern is found, the long-run impact of depreciation of the dollar is found to be favorable. In this paper we consider the trade balance of Japan. We investigate the short- and long-run impact of real depreciation of the yen on the Japanese trade balance using bilateral data between Japan and each of its major trading partners, including Australia, Canada, France, Germany, Italy, the Netherlands, Switzerland, the United Kingdom, and the United States. The evidence of the J-Curve was present only in the trade between Japan and Germany in one relation and Japan and Italy in another relation. In the remaining cases, no specific pattern was observed. The long-run effect of real depreciation of the yen was favorable only in the cases of Canada, the United Kingdom, and the United States. Lack of significant relationship between Japanese trade balance and real value of the yen in most instances could be due to Japanese firms’ pricing policies. In order to maintain their market shares, Japanese firms in the past have adjusted prices to offset movement in exchange rates.