ABSTRACT
The possibility that a currency supply curve slopes downwards rather than upwards is not a mere curiosity with little practical relevance. Rather, it is a realistic possibility that is critical to explaining why foreign exchange markets may be unstable. This possibility has attracted substantial interest because of the extreme volatility of exchange rates during certain times. It is also of interest because the condition for exchange-rate instability helps explain the socalled ‘‘J curve’’ whereby, for example, a depreciation of a currency worsens rather than improves a country’s trade balance. The cause of the J curve and of exchange-rate instability can be understood by applying the central economic paradigm of supply and demand.
