J curve

The shape of the trend of a country’s trade balance following a devaluation. A lower exchange rate initially means cheaper exports and more expensive imports, making the current account worse (a bigger deficit or smaller surplus). After a while, though, the volume of exports will start to rise because of their lower price to foreign buyers, and domestic consumers will buy fewer of the costlier imports. Eventually, the trade balance will improve on what it was before the devaluation. If there is a currency appreciation there may be an inverted J-curve.

Following the depreciation/devaluation of the currency the volume of imports and exports will remain level due in part to pre-existing contracts for imported goods that have to be honoured. However, the depreciation in the pound will cause the price of imports to rise and therefore total spending on imports will subsequently increase; it is this that causes the worsening of the current account.

Over the longer term a depreciation in the exchange rate can have the desired effect of improving the current account balance—as can be seen in the diagram expenditure switching will occur. Demand for exports picks up and domestic consumers will switch their expenditure to domestic products and away from expensive imported goods and services. Equally, many foreign consumers may switch to purchasing cheaper British products instead of their own domestically produced goods and services. This is represented on the diagram by the movement towards a balance of trade surplus.