Answer to Question #116707 in Macroeconomics for Bayramhan Demircan

Question

Consider an economy where the
current account is negatively affected by a depreciation in the real exchange rate in the short
run (that is, the Marshall-Lerner condition does not hold). Explain the effects of a monetary
expansion in this economy by comparing it to the baseline case where the Marshall-Lerner
condition holds. Use a graphical analysis accompanied by an intuitive (verbal) explanation.
(UPDATE: Assume that the DD curve under the revised assumption will be steeper than the AA
curve.)

Answer 1

If the Marshall-Lerner condition does not hold and the depreciation in the real exchange rate is negatively affecte by account, monetary expansion in this economy has following:

More money- less exchange rate-more expensive price for imported goods-welfare is falling

When the Marshall-Lerner condition holds happens following:

More money- less exchange rate-more export-the exchange rate is growing-the exchange rate stabilizing.