consumption patterns and trade contracts (Bahmani-Oskooee and Ratha, 2004). However, although the balance of trade may deteriorate in the short-term, it will improve in the long-term as market participants adjust to the new prices. This is commonly referred to as the _J_ -curve effect. The _J_ -curve refers to the trajectory of the country’s trade balance following devaluation.

**Table 2. Effects of Devaluation on Exports and Imports in Ethiopia**

|**Dependent**<br>**Variable**|**ln(Real**<br>**exports)**<br>**(1)**|**ln(Real**<br>**imports)**<br>**(2)**|**ln(Manufacturing**<br>**exports)**<br>**(3)**|**ln(Agricultural**<br>**exports)**<br>**(3)**|
|---|---|---|---|---|
|ln(REER)|**–0.50*****|**0.59*****|**–1.06****|**–0.33***|
||(2.83)|(3.45)|(2.04)|(1.81)|
|ln(Domestic income)||0.55***<br>(3.16)|||
|ln(World income)|6.36***<br>(5.42)||4.59**<br>(2.28)|1.21**<br>(2.19)|

Note: _t_ -values in parenthesis. The empirical models allow for a linear trend to account for the trending nature of the variables and a broken linear trend in 1992 to capture the significant change in trend slopes (and thus the mean-shift in growth rates) due to the political and economic regime change. ***, **, * indicate statistical significance at the one, five, and ten percent, respectively. Source: Haile (2015a,b).

In Ethiopia, using the REER index, a 1 percent real devaluation increases exports by 0.5 percent and reduce imports by about 0.6 percent, thereby leading to an improvement in the trade balance of around 1.1 percent (Haile, 2015a). These results conform to economic theory as a policy of devaluation is expected to have both expenditure-switching (from foreign to domestic goods) and expenditurereducing (reduction in import demand) effects. The empirical estimates in Table 2 (columns 1 and 2), which represent causal effects, suggest that the sum (in absolute value) of export and import elasticities with respect to the real effective exchange rate is 1.1. Therefore, the ML condition is satisfied for Ethiopia, suggesting that a real devaluation of the birr will significantly improve the trade balance. This key finding holds up well against various sensitivity checks. Similar results are obtained using quarterly data for the sub-periods 1993-2013 and 2004-13. The short-run analysis provides robust evidence that Ethiopia’s trade balance does not exhibit the so-called _J_ -curve pattern following devaluation. In other words, the long-term improvement in Ethiopia’s external balance would be achieved without any significant shortterm deterioration in the trade balance (see Annex I).

Further analysis reveals that a 1 percent real devaluation increases Ethiopia’s manufacturing exports by 1.06 percent and agricultural exports by 0.33 percent (Haile, 2015b). The results in Table 2 (columns 3

**Figure 11. Contributions to Changes in the Current Account Balance (2010-13) (% GDP)**

<!-- Start of picture text -->
1.0%<br>0.5% Credit growth<br>0.0%<br>-0.5% FDI Lag NFA (share in GDP)<br>-1.0% Terms of trade Fiscal balance instrumented (share in GDP)<br>Relative openness (lag)<br>-1.5%<br>Real Aging speed<br>-2.0%<br>effective  Relative GDP growth<br>-2.5%<br>exchange Lag CA<br>-3.0% rate Inflation volatility (3 year average, lag)<br>-3.5% Relative income<br>-4.0%<br><!-- End of picture text -->

change compared to previous period (2010-2011) <!-- Start of picture text --> Source: Portugal and Zildovic (2014).<br><!-- End of picture text --> <mark>Source: Portugal and Zildovic (2014).</mark> 15