Permanent and temporary changes in the exchange rate and trade balance dynamics

Abstract

This paper analyzes some causes and macroeconomic consequences of J-curve effects. The Mundell-Fleming model is extended to allow for a delivery lag, exchange rate expectations, and short-run wage rigidity. It is shown that an unanticipated permanent increase in the money supply creates a J-curve effect, with the length of the J-curve depending on the degree of confusion between permanent and temporary shocks. Also, the permanent vs. temporary confusion produces persistence in the movements of real variables even if the rigidity of wages and prices is of short duration. © 1983.