Exchange Rate and External Trade Flows: Empirical Evidence of J-Curve Effect in Ghana

Ghana’s external trade has remained in perpetual deficits over the three decades alongside depreciating domestic currency. This paper therefore examines the effect of real exchange rate (RER) movements on Ghana’s external trade performance, using a battery of times series models. The study particularly assesses the validity of Marshall-Lerner Condition, the J-Curve and Kulkarni Hypotheses in the case of Ghana. The empirical analysis reveals inelastic responses of both export and import demand to changes in RER. We found a steady long run link between RER movements and Ghana’s trade balance. However, the impact of RER on Ghana’s trade balance was found to be asymmetric. Periods of minimal real depreciation (a “tranquil” regime) lend support to Marshall-Lerner Condition (MLC), the J-Curve theory and Kulkarni Hypothesis in the context of Ghana. In contrast, we found less visible evidence of J-curve for periods of excessive real depreciation (an “intemperate” regime). It is therefore critical to sustain macroeconomic stability in order to engender low and stable inflation and stable foreign exchange rates. This however requires the adoption of appropriate and coordinated monetary and fiscal policies.