Question: Is the Marshall-Lerner condition satisfied in practice? 1) Historical examples Italy...
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Transcript of Question: Is the Marshall-Lerner condition satisfied in practice? 1) Historical examples Italy...
• Question: Is the Marshall-Lerner condition satisfied in practice?
1) Historical examples• Italy 1992-93• Poland 2009
2) Econometric estimation of elasticities• OLS• The J-curve
3) Both determinants together: Real exchange rate & income• Keynesian model of the TB• Estimation for the case of East Asian countries
LECTURE 2: THE TRADE BALANCE IN PRACTICE
Professor Jeffrey Frankel, Kennedy School, Harvard University
1992 devaluation
Rise in trade balance
(i) Italy devalued in Europe’s 1992 ERM crisis. The lira’s Real Effective Exchange Rate value & effect on its trade balance.
Historical examples
I III V VII IX XI I III V VII IX XI I III V VII IX
2008 2009 2010
3.2
3.5
3.7
4.0
4.2
4.5
4.7
(ii) Poland’s Exchange Rate Rose 35% when Global Financial Crisis hit in late 2008.
Source: Cezary Wójcik
Zlot
y/€
Poland’s trade balance improved sharply in 2009while its European trading partners all went into recession.
Source: National Bank of Poland From FocusEconomics 2014
Trade balance in billions of euros
=> Poland avoided recession.
Contribution of Net X in 2009: 3.1% of GDP > Total GDP growth: 1.7%
A textbook case where depreciation was expansionary: Poland, the only continental EU member with a floating rate,
was also the only one to escape negative growthin the global recession of 2009.
2006 2007 2008 2009 2010 Exchange Rate
Poland6.2 6.8 5.1 1.7 3.5f
Floating
Lithuania7.8 9.8 2.9 -14.7 -0.6f
Fixed
Latvia12.2 10.0 -4.2 -18.0 -3.5f
Fixed
Estonia10.6 6.9 -5.1 -13.9 0.9f
Fixed
Slovakia8.5 10.6 6.2 -4.7 2.7f
Euro
Czech Republic6.8 6.1 2.5 -4.1 1.6f
Flexible
Hungary3.6 0.8 0.8 -6.7 0.0f
Flexible
Source: Cezary Wójcik, 2010
(de facto)
% change in GDP
Empirical estimation of export & import elasticities
• Coefficient estimated by OLS regression.– In logs, so parameters are elasticities.
log of Xdemanded
log of EP*/P ≡ Price of foreign goods relative to domestic goods
Common econometric finding
• Estimated trade elasticities with respect to relative prices often ≈ 1, after a few years have been allowed to pass.– => Marshall-Lerner condition holds in the medium run.– e.g., Marquez (2002).
• Some face a higher elasticity of demand for their exports:– small countries, and– producers of agricultural & mineral commodities or other
commodities that are close substitutes for competitors’ exports.
Common empirical observation:After a devaluation, trade balance gets worse before it gets better.
Explanation:Even if devaluation is instantly passed throughto higher import prices,buyers react with a lag.
Also, in practice, it may take time up frontbefore the devaluation is passed through to import prices.
The trade balance is a function of both the real exchange rate and income.
• Recall the Keynesian model of the trade balance from Lecture (iii) of the pre-semester Macro Review.
• Micro theory: The demand for the import or export good, as for any good, is a function of both price & income.
Keynesian Model of the Trade Balance
Import demand is a function of the exchange rate & income. The same for exports: => X = X(E, Y*) M = M(E, Y).
.
If the domestic country is small, Y* is exogenous.
0dE
dX
0**
mdY
dX0m
dY
dM
0dE
dM
Estimated price elasticities (LR)
satisfy the Marshall-Lerner
Condition.Estimated income elasticities are mostly
between 1.0 - 2.0.
END OF LECTURE 2: THE TRADE BALANCE IN PRACTICE
After big devaluations
in Mexico in 1994
and Korea
& Southeast Asia in 1997,
trade balances “improved” quickly, but because of expenditure-reduction, not expenditure-switching.
Appendix 1 -- Morehistorical examples: EM currency crises of the 1990s.
Professor Jeffrey Frankel, Kennedy School, Harvard University
• Why did trade fall so much more sharply than income in the 2008-09 global recession?
Appendix 2–
An application of the marginal propensity to import
An application of the marginal propensity to import:
Bussière, Callegari, Ghironi, Sestieri, & N.Yamano, 2013,"Estimating Trade Elasticities: Demand Composition and the Trade Collapse of 2008-2009."
Why did trade fall so much more sharply than income in the 2008-09 global recession?
2009
Bussière, Callegari, Ghironi, Sestieri, & Yamano, 2013, "Estimating Trade Elasticities: Demand Composition and the Trade Collapse of 2008-09."
Why did trade fall so sharply in the 2008-09 global recession?
The usual explanations involve trade credit, inventories, and trade in intermediate inputs.
Behavior of real components of GDP in the 2008-09 recession
Demand, adjusted for import-intensity
GDP
Investment
Imports & Exports
Bussière, Callegari, Ghironi, Sestieri, & N.Yamano, "Estimating Trade Elasticities: Demand Composition and the Trade Collapse of 2008-2009.“
Bussière et al (2013) argue that Investment, which declined much more in 2009 than the other components of GDP, has
a higher marginal propensity to import than the other components.