Revisiting the J-Curve: Nonlinear Exchange Rate Dynamics and Trade Balance Between Pakistan and China

Abstract

Recent developments in econometric modeling have reinvigorated discussions on the J-curve phenomenon and the broader implications of exchange rate movements on trade balances. This study employs a linear autoregressive distributed lag model to examine the symmetrical effects of exchange rate fluctuations on commodity-level trade between Pakistan and China, utilizing annual data spanning from 1980 to 2023. This nonlinear approach decomposes the real bilateral exchange rate into two distinct phases, appreciation and depreciation allowing for a more detailed investigation into how currency fluctuations impact trade balances differently across various industries. Unlike the linear model, which assumes a uniform effect, the nonlinear model captures the asymmetric nature of exchange rate shifts, providing a more comprehensive understanding of trade dynamics. The empirical findings, illustrated through extensive data tables, offer strong evidence in support of the J-curve theory, indicating that in the short run, currency depreciation initially exacerbates trade deficits before eventually leading to improvements. By incorporating nonlinearities in economic modeling, this study provides a refined perspective on the trade relationship between Pakistan and China, highlighting the necessity of acknowledging asymmetric exchange rate effects when formulating trade policies. These insights serve as a valuable resource for policymakers, enabling them to develop more effective strategies for managing currency fluctuations and fostering economic stability.