Does a Devaluation Improve the Trade Balance: Evaluating Competing Theories with New Evidence from Small Semi-Open Economies*

This paper confronts exchange rate-trade balance hypotheses derived from the elasticity, absorption/switching and monetary approaches to the balance of payments and short-run disequilibrium effects such as the J and S curves with data from a wide range of developing countries. We find strong evidence that the exchange rate affects the trade balance long-run equilibrium even when money and income effects are accounted for explicitly. In the short-run, a devaluation generally worsens the trade balance, at least at the first lag, and then improves it. The findings do not consistently favor or reject hypotheses from the absorption/switching and monetary approaches. JEL classification: F31; F32; F41; E58; C32; C51; C52