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The Marshall-Lerner condition and exchange market stability. A theoretical note

Publication date: 
Tuesday 31 March 2015
Mariano de Miguel

This theoretical note is aimed at reconsidering the Marshall-Lerner condition (M-L) in the version that is usually presented in texts and manuals on the matter, so as to make clear some of its main assumptions and assess the extent to which the condition is altered when these assumptions are modified. If the currency adjustment is ignored by means of a contraction in domestic economic activity –giving the model an overt sense of unreality, but being very useful for a fundamental analysis– the M-L condition will depend on the absolute value of foreign trade elasticities. A non-gravitating country in global supply and demand of exports and of imports faces a less-restrictive M-L condition; nonetheless, that does not judge on the convenience of a devaluation policy as a tool to improve foreign trade balance. With reduced foreign trade elasticities, low unemployment and wage resistance, the size of the required nominal devaluation can bring about unnecessarily high costs that are consequently unjustifiable. The analysis of the terms of trade determinants, in their mercantile and factorial versions, comes up as an axis for prospective research, due to its relevance in the final expression of the M-L condition and in the degrees of foreign freedom that countries possess to exercise an autonomous and self-centred economic policy. The pessimism in foreign trade elasticities is the reverse side of the optimism in revaluation.

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