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Published online by Cambridge University Press: 07 November 2014
Under what conditions can depreciation of the currency be relied on to correct a passive balance of payments? The question has interested theorists at least since Bickerdike's pioneering article of 1920 and in the post-war years has been the subject of an intensive and.long-drawn-out polemic. There is now on file a formula for each of umpteen different situations and one might feel tolerantly towards anyone who cried “Enough.” Yet, as I hope to show, important work remains to be done.
Almost without exception, existing solutions to the exchange stability problem have been derived by analysis of the “comparative equilibria” variety. It is assumed that, before and after depreciation, all commodity markets, international as well as purely domestic, are in equilibrium, in the sense that ex ante demand is equal to ex ante supply at the going price. Analysis of the problem consists in the location and, with an eye on the balance of payments, the comparison of the two equilibria.
I suspect, however, that depreciation often is mooted in a context of widespread disequilibrium in commodity markets. For, granted only that at some previous point in time the balance of payments was in equilibrium, present difficulties must be the aftermath of a “disturbance,” and it is difficult to conceive of a disturbance which impinges on the market for foreign exchange but not on the markets for individual commodities. In a context of market disequilibrium, then, what are the minimal conditions of exchange stability?
The present paper is a revised version of part of a larger paper which was read at the annual meeting of the Canadian Political Science Association in Saskatoon, June 5, 1959.
I am indebted to members of the Association, particularly to Messrs. A. E. Safarian, P. Cornell, and D. B. Marsh, for helpful comment.
1 Bickerdike, C. F., “The Instability of Foreign Exchange,” Economic Journal, XXX, 03, 1920, 118–22.CrossRefGoogle Scholar
2 A possible example is an inter-governmental transfer, financed in the transferor country by an increase in borrowing from the cental bank and offset in the transferee country by a decrease in borrowing from the central bank.
3 In time of war (or preparation for war, or reconstruction after war) prices may be subjected to deliberate governmental control; in calmer times oligopolistic pricing practices may retard the response of prices to a change in demand.
4 Michael Michaely has examined the problem on different assumptions. See his “Domestic Effects of Devaluation under Repressed Inflation,” Journal of Political Economy, LXIII, 12, 1955, 512–24.Google Scholar
5 In describing the first alternative, I have ignored the possibility that foreign demand may exhaust the full employment output of the depreciating country. The neglect is, however, easily justified. For this “corner” case is already covered by my description of the second alternative–it need be assumed only that the entire output of the depreciating country is allocated to foreign buyers. Similarly, in describing the second alternative I have ignored the possibility that the foreign demand price for the export allocation may fall short of the pegged home price. This neglect may be justified too. For, in the eventuality described, the export supply of the depreciating country is perfectly elastic up to the amount allocated to export markets; it is covered, therefore, by the second alternative. A third pure alternative, in which the domestic market is given priority, is uninteresting since it does not give rise to excess demand.
6 See Laursen, S. and Metzler, L. A., “Flexible Exchange Rates and the Theory of Employment,” Review of Economics and Statistics, XXXII, 08, 1950, 281–99.CrossRefGoogle Scholar
7 See Spraos, John, “Consumers' Behaviour and the Conditions for Exchange Stability,” Economica (N.S.), XXII, 05, 1955, 137–47.CrossRefGoogle Scholar
8 See Harberger, Arnold C., “Currency Depreciation, Income and the Balance of Trade,” Journal of Political Economy, LVIII, 02, 1950, 47–60 CrossRefGoogle Scholar, and Pearce, I. F., “A Note on Mr. Spraos' Paper,” Economica (N.S.), XXII, 05, 1955, 147–51, esp. 147-8.CrossRefGoogle Scholar
9 The formal model to be exploited in this section has an alternative interpretation. Imagine that commodities are divided into two classes—those exported but not consumed at home, and those produced for the domestic market only—and that it is impossible, during the period considered, to shift factors of production between the two classes of industry. The results obtained are immedately amenable to this interpretation.