Exchange Rate Cycles in the Mundell-Fleming Model when the Marshall-Lerner Condition is Violated

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In many standard undergraduate textbooks of macroeconomics, open economies are discussed by means of the Mundell−Fleming model, an open macroeconomic version of the IS−LM model. This short paper develops a simple differential−equation version of the dynamic Mundell−Fleming model, taking account of two key assumptions : (i) the Marshall−Lerner condition is globally violated and (ii) the investment function depends nonlinearly on the current output level. Under our settings, we demonstrate that the exchange rate and the other relevant variables can display persistent fluctuations due to the occurrence of a stable limit cycle. We also discuss a paradox that the resulting dynamics may well be consistent with the J−curve effect.

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