Testing the Marshall-Lerner Condition and the J-Curve Phenomenon for Pakistan : Some New Insights

Purpose: This study tests the Marshall-Lerner condition and the J-curve Phenomenon for Pakistan by using the quarterly data from the third quarter of 1970 till the fourth quarter of 2012. Methodology: Johansen's Cointegration technique and Vector Error Correction models are employed for the purpose of long-run and short-run estimations respectively. Findings: Results of the study indicate that Marshall-Lerner condition does hold in the long run for Pakistan but not in the short run, thus supporting the phenomenon of J-curve. But it is found that the absolute sum of imports and exports price elasticities of demand barely exceed 1, indicating that a real devaluation of rupee will only improve the trade balance of Pakistan a little. Therefore, in case of Pakistan, devaluation/depreciation of rupee cannot be considered as an important policy instrument to decrease the deficit in balance of payments due to its weak influence over the trade balance. Furthermore, the results of the study hold for the real exchange rate devaluation only and not necessarily for the nominal devaluation, since it is found that nominal devaluation does not always result in real devaluation due to increase in the domestic prices relative to the foreign prices. Recommendations: The current study opens up new insights for policy makers