A formal model of krugman’s intuition on the J-curve

Olivier Cardi and Luisito Bertinelli

No 2004043, LIDAM Discussion Papers CORE from Université catholique de Louvain, Center for Operations Research and Econometrics (CORE)

Abstract: We use a two-good dynamic intertemporal general equilibrium model to formalize the economic intuition of Krugman about the explanation of the J-curve phenomenon in terms of habit persistence in consumption and sluggishness in capital adjustment. The results differ markedly according to the permanence or temporary nature of the shock. A short-lived terms of trade worsening may give rise to a once-for-all decrease in the marginal utility of wealth, a hump-shape response of real expense when the perturbation is at work and a definitely higher level of consumption at the new steady-state. Habitual standard of living and welfare are raised through the combination of an intertemporal speculation, habit persistence, and hysteresis effects. In accordance with recent empirical results, investment is procyclical, H-L-M effect holds, net foreign assets adjustment exhibits a J-curve, current account surplus is associated with a fall in real income. From an analytical viewpoint, a new consistent procedure to study temporary shocks in continuous time leads to formal solutions that allow to investigate accurately transitional dynamics in a complex dynamic system, comparing transitory and permanent perturbations analytically, underscoring hysteresis phenomenon, and bringing out the determinants of short and long-term reactions of macroeconomic aggregates.

Keywords: current account; habit formation; temporary shock; J-curve (search for similar items in EconPapers)
JEL-codes: E21 E22 F32 F41 (search for similar items in EconPapers)
Date: 2004-06
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