Page 79 - Azerbaijan State University of Economics

J-CURVE AND THE MARSHALL-LERNER CONDITION - THE CASE OF AZERBAIJAN

exchange rate were taken from the Central Bank of Azerbaijan statistical

database. Eurozone’s IPI comes from EUROSTAT. All the variables are
real, and in a monthly format. The share of the Eurozone accounts for

approximately 50% of Azerbaijan’s aggregate foreign trade.

3. Methodology

The trade balance model employed in this study is estimated by the
following long-run – co integrating – reduced form equations:

ln(X t) = α 0+ β x(RFX t) + β eur(lnY eur) + ε t (1)

ln(IM t) = α 0+ β im(RFX t) + β az(lnY az) + ε t (2)

where, ln is the natural logarithm, X and IM are the values of non-oil

exports and imports respectively, RFX is the real bilateral exchange rate,
Y eur is the Industrial Production Index of the Eurozone, Y az is the real

GDP of Azerbaijan, and ε t is the error term. Based on the above
definitions, an increase in the value of RFX would mean a depreciation

of the manat. It is a priori expected that the signs of export and import

elasticity’s (β x and β im) will be positive and negative respectively. A
positive sign for the foreign or domestic production coefficient (Y eur and

Y az) would mean that Azerbaijani exports, or imports, are demand
driven. The Marshall-Lerner condition will hold if the sum of the export

and import elasticity’s exceeds 1.
As a brief theoretical note, a partial derivative of the balance of

trade with respect to the exchange rate would show a direct impact of the

depreciation. However, a one-time movement in the exchange rate will
affect not only the trade balance, exports, or imports, but also the future

exchange rate, which in turn will carry an additional effect on the trade
aggregates, etc. It is important to account for these feedback effects to

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