Elasticities and timing

1. The Marshall-Lerner condition sets when a depreciation or devaluation improves the current account.
2. It improves only if the price elasticities of demand for exports and imports sum to more than one.
3. The J-curve shows the current account worsening before it improves, because volumes adjust more slowly than prices.

The Marshall-Lerner condition

1. A depreciation lowers export prices in foreign currency and raises import prices at home.
2. Whether the current account improves depends on how far the quantities of exports and imports respond.
3. If the elasticities of demand for exports and imports sum to more than one, higher export volumes and lower import volumes outweigh the dearer import prices, so the balance improves.
4. If they sum to less than one, the higher import bill dominates and the balance worsens.

Marshall-Lerner condition: PED (exports) + PED (imports) > 1

The J-curve

1. On the diagram, time is on the horizontal axis and the current account balance on the vertical axis.
2. At first, volumes are slow to respond because contracts are fixed and buyers take time to switch supplier.
3. Dearer imports raise the import bill straight away, so the current account worsens at first.
4. As volumes adjust, exports rise and imports fall, so the balance improves and traces a J shape.

Linking the two

1. The J-curve is the path over time towards the Marshall-Lerner result.
2. The short-run dip reflects slow volume adjustment, when the elasticities are still small.
3. The later recovery reflects the elasticity condition finally holding as volumes respond.
4. So the two ideas describe the timing and the condition together, so it depends on both elasticity and the length of the lag.

Is a depreciation a reliable way to strengthen the external economy?

1. In its favour, where the Marshall-Lerner condition holds a depreciation lowers export prices and raises import prices, so net exports, output and jobs rise and a current account deficit narrows without deflating demand.
2. Against this, the J-curve means the balance worsens first, while dearer imports raise cost-push inflation and worsen the terms of trade, so the competitiveness gain can be partly offset.
3. It also depends on context: the gains are largest with spare capacity and price-sensitive, diversified exports, but small for commodity exporters or economies reliant on imported inputs, and they erode if trading partners retaliate or devalue in turn.
4. On balance, a depreciation can strengthen the external position, but the outcome depends on the size of the elasticities, the time horizon, the inflation response and how trading partners react.