Marshall-Lerner Condition

Marshall-Lerner condition – real depreciation leads to increase in net exports

• NX = X(Y*,e) – IM(Y,e)/e
• real depreciation >> e decrease
• exports increase (domestic goods become relatively cheaper than foreign goods)
• imports decrease (under this condition)
  • though e decrease increases multiplied effect of IM
• trade balance improves when exports increase enough and imports decrease enough to overcome the real exchange rate increase
• dNX/de < 0
• depreciation >> makes foreign goods relatively more expensive >> makes citizens (who need imports) worse off
  • shifts up demand curve by same amount that NX curve shifts up

constant production – uses both depreciation and fiscal contraction

• reduces trade deficit
• fiscal contraction decreases demand
• depreciation increases demand, chances net exports graph to improve trade balance

J-curve – firms take time to adjust to depreciation

• depreciation initially decreases net exports before increasing it
  • firms (possibly under contract) don't switch to cheaper alternatives at first >> still working under rules of past exchange rate
• history shows real exchange rate tied w/ net export changes
• significant time lags in response of trade balance to real exchange rate changes

saving and trade balance –

• NX = X – (epsilon)IM = Y – C – I – G
  • S = Y – C – T
  • NX = Y + T – I - G
• NX = S + (T-G) – I
  • trade balance equals private saving (S) and public saving (T-G) minus investment
  • trade surplus >> more saving than investment
  • trade deficit >> more investment than saving
• investment increase comes w/ increase in private/public saving, or decrease in trade balance
  • private savings, investment constant >> increasing budget deficit would worsen trade balance
• budget deficit increase comes w/ increase in private saving, decrease in investment or trade balance
• country w/ high saving rate (private/public) >> high investment rate or large trade surplus