Estimating a bilateral J‐curve between the UK and the Euro area: An asymmetric analysis

Abstract

The J-curve outlines the path of movement in the trade balance after a currency is devalued or depreciated, deteriorating in the short run but improving in the long run. One study in this journal investigated the concept between the UK and each of its 10 large partners from the EU. The study found support for the J-curve effect in the UK trade balance with Belgium, Germany, France, Italy and Netherlands. However, the findings were based on sign misinterpretation. If correctly interpreted, the findings actually support the inverse J-curve, i.e., long-run deterioration in the bilateral trade balances. The results were based on using the linear ARDL approach. We revisit the issue and use the Nonlinear ARDL approach. We find support for the asymmetric Jcurve effect in the bilateral trade balance between the UK and France, Greece, Portugal and Spain and an asymmetric inverse J-curve in the case of Finland.

A reply to “Estimating a bilateral J‐curve between the UK and the euro area: An asymmetric analysis”

“…In their estimates, Bahmani‐Oskooee and Karamelikli (2021) find a positive long‐run relationship between TB and REX in their linear ARDL, however, only for two countries (Belgium and France). The overall impact should be interpreted in a similar manner given that the reverse definition of REX is countered by the reverse definition of TB (the authors define the TB as UK imports over UK exports).…”

“…The main source of issue comes via the interpretation of the REX i term, which, in both papers, is defined as P UK * NEX / P i , where P i is the price level (measured by the Harmonized Index of Consumer Prices (HICP)) of each euro area country, respectively, P UK is the UK’s price level, and NEX is the number of euros per sterling pounds. In my paper, I had noted that an increase in the REX should be viewed as a real depreciation of the pound, which, as Bahmani‐Oskooee and Karamelikli (2021) correctly note, does not hold if the variables are created as stated in the Appendix of Michail (2018).…”

“…In this year's issue, the article by Bahmani‐Oskooee and Karamelikli (2021) suggested that the findings of Michail (2018) were based on sign misinterpretation, and if correctly interpreted, the results actually support the inverse J‐curve, that is, long‐run deterioration in the bilateral trade balances. These conclusions were reached using a nonlinear AutoRegressive Distributed Lag (ARDL) approach while my paper had employed a linear ARDL approach.…”

“…A depreciation of sterling would suggest that the exchange rate moves to 1.10 euros, with the REX term declining as a result. As such, in such a specification, Bahmani‐Oskooee and Karamelikli (2021) are correct to note that a decrease in the REX should be viewed as a real depreciation.…”

“…Hence, in this setup, the Michail (2018) interpretation that an increase in REX would imply a real depreciation of the British pound is correct. Overall, while the opposite specification is usually employed, that is, the one suggested by Bahmani‐Oskooee and Karamelikli (2021), the use of sterling pounds per euro is not prohibitive to reach equally valid conclusions, provided that they are correctly interpreted.…”