Marshall-Lerner Condition
Definition
Marshall-Lerner Condition
A condition which determines the level of success a depreciation or devaluation of a currency rate of exchange will have on improving a current account deficit in the balance of payments.
For this condition, there are two key notations:
- $ PED_m = PED_{imports} = \text{PED of country's imports for depreciating country}$
- $ PED_x = PED_{exports} = \text{PED of country's exports for foreigners}$
The summary for the condition is:
- If the sum of $PED_x$ and $PED_m$ is greater than one ($PED_x + PED_m > 1$) then the depreciation of the currency will reduce the current account deficit.
- If the sum of $PED_x$ and $PED_m$ is less than one ($PED_x + PED_m < 1$) then the depreciation of the currency will increase the current account deficit.
- If the sum of $PED_x$ and $PED_m$ is equal to one ($PED_x + PED_m = 1$) then the depreciation of the currency will not affect the current account deficit.
Alongside this, the greater the $PED_m$, the better the improvements possible in the trade balance (current account deficit).
J-Curve
- The J-curve effect is when there might be an even further deficit in the current account or larger trade imbalance immediately after the depreciation of the currency.
- Then, the current account deficit will start to minimise, and the trade balance will improve, provided the depreciating country is meeting the Marshall-Lerner condition (Sum of PEDS > 1).
- Observing the figure below, the axis labelling is different from other diagrams with the x-axis representing the time and y-axis representing the balance of trade.
- Trade balance at zero refers to when imports is equal to exports.
- Below zero indicates to trade deficit and above zero indicates trade surplus.
- The J-curve effect can be observed as the curve dips right after the depreciation of the currency.
