Empirical evidence of an S-curve in Croatia

Abstract

The impact of currency depreciation on the trade balance is still an empirically unanswered question within international and financial economics. This paper is pointed towards partial clarification of that question as the author analyses trade perspectives in Croatia through the concept of an S-curve. The S-curve is an extension of the J-curve, for the impact of exchange rate depreciation wears out after a while and there is no further improvement when all impacts are realised, meaning that at the top of the curve the slope is zero or negative. By focusing on the relationship between the terms of trade (exchange rate) and trade balance the author is trying to provide some new insights into trade dynamics over a business cycle in Croatia. The main result is that both unconditional and conditional relations (conditional to technology's role identified in the vector error correction model) are consistent with the empirical S-curve pattern of cross-correlations between the trade balance and the terms of trade (exchange rate). Nonetheless, the inability of the S-curve to depict the strength and/or the speed of the adjustment process before and after the terms of trade/exchange rate depreciation explains its limitation within policy recommendations for Croatia.