Marshall – Lerner Condition

Marshall – Lerner Condition

 Real depreciation leads to improvement of CA in general
though there are Volume Effect, Value Effect and J-Curve etc
linked to real depreciation of currency.

 Marshall – Lerner Condition: ceteris paribus, a real

depreciation improves CA if export and import volumes are
sufficiently elastic with respect to the real exchange rate.

 CA functional form:

CA(q, Y d ) X (q) M ( q, Y d )
M M X
0, 0, 0
q Yd q

Sunandan Ghosh, CDS, 2013 2

Marshall – Lerner Condition
 Now, H-import is equal to F-export (2 country case)
M q X*
 Hence, we can re-write the CA function as –
CA(q, Y d ) X ( q ) q X * ( q, Y d )

 Let’s define the following derivatives –

X X*
Xq 0, X q* 0
q q
 Hence, a change in CA can be written as –
CA CA2 CA1 (X2 q2 X q* ) ( X 1 q1 X 1* )
( X ) ( q2 X q* ) ( q X 1* )
Sunandan Ghosh, CDS, 2013 3
Marshall – Lerner Condition
 Change in CA due to real depreciation is –
CA X X*
q2 X 1*
q q q
Xq q2 X q* X 1*
X X*
 Now we already have X q 0, X q* 0
q q
 Hence, first two terms are positive – gives the volume effect;
last term is negative – gives the value effect.

 To have the entire thing positive we need volume effect

dominating value effect.

Sunandan Ghosh, CDS, 2013 4

Marshall – Lerner Condition
 For that we define export demand elasticities with respect
to real exchange rate –

X X1 q1 X q1
Xq
q q1 X1 q X1
* q1 *
*
Xq
X1
 Plugging these values in the change in CA equation we can
show that
CA *
0 if ( ) 1
q
 This is known as the Marshall – Lerner Condition.

Sunandan Ghosh, CDS, 2013 5