Assessing the Marshall–Lerner condition within a stock-flow consistent model

Emilio Carnevali, Giuseppe Fontana and Marco Veronese Passarella

Cambridge Journal of Economics, 2020, vol. 44, issue 4, 891-918

Abstract: We derive the general equilibrium condition for the terms of trade in a two-country economy model. We show that the Marshall–Lerner condition is only a special case of this condition, in which a full exchange rate pass-through to import prices is assumed. In fact, the Marshall–Lerner condition is not even a ‘useful approximation’ of the general condition. For the full pass-through assumption has destabilising, rather than stabilizing, effects, when it is introduced in a stock-flow consistent dynamic model. More generally, the higher (lower) the pass-through, the slower (quicker) is the adjustment of the economy towards the equilibrium. This is tantamount to saying that the speed of adjustment is a positive function of the strategic behaviour of the exporters, who attempt to retain their market share by keeping their foreign currency-denominated prices unchanged.

Keywords: Marshall-Lerner condition; Stock-flow consistent models; Exchange rate (search for similar items in EconPapers)
Date: 2020
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