Question

Explain and compare: Marshall-Lerner Theorem, Mundell-Flemming Model and how both relate to the "Imposible Trinity" in International Business

(Make sure to use a real example in current world times)

Answer 1

Marshall lerner theorem states that the current account of a country will improve if the currency depreciates, which ultimately means because of the decline in value the country will gain more from exports and earn more on its current account. Its BOP will improve only if the price elasticity of demand of long term export and import is greater then one. Price effect is negative and volume effect is positive. Thus if one has to relate it with the impossible trinity, one can say that there can't be fixed interest rate as that would not benefit the BOP balance. In this model only two of the three can hold for the theorem to be relevant and impactful.

The Mundell fleming model states that the economy cannot maintain all three trinities at once that is fixed exchange rate, free capital movement and an independent monetary policy. That an economy can only maintain two of the three at the same time, which is also called the impossible trinity. Mundell fleming model is used for exchange rate determination. Free capital flows and independent monetary policy will help drive the domestic economy as interest rates fall because of higher money flows, this leads to depreciation in the domestic currency which will eventually drive up the current account because of increase in trade.