Stabilisation Policy in an Open Economy

  • Graham Bird


The question to be tackled in this chapter relates to how macroeconomic policies may be organised to achieve their principal objectives. An approved way of approaching this question is, first, to describe the targets that the policy-making authorities are setting out to achieve, second, to describe the policy instruments through which attempts are made to realise these targets, and third, to analyse how the instruments may be combined in the most efficient fashion.


Exchange Rate Interest Rate Monetary Policy Fiscal Policy Capital Inflow 
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Notes and References

  1. 1.
    These are all important issues. Fortunately there are a number of textbooks available which discuss such questions and readers are advised to consult one of them. A very brief review may be found in Graham Bird, World Finance and Adjustment: An Agenda for Reform (London: Macmillan, 1985). Additional references are mentioned in the ‘Further Reading’ section.CrossRefGoogle Scholar
  2. 2.
    In preference to the fixed targets approach it may be better to think in terms of a social welfare function with targets being arguments in this function. Here the policy-makers’ objective is to maximise the welfare function subject to certain policy constraints, allowing for the fact that certain targets may be seen as being more important than others and that there may be trade-offs between them.Google Scholar
  3. 3.
    For clarification of this see an intermediate macroeconomic textbook. The basic idea behind Say’s Law is that supply creates its own demand, while with the gold standard mechanism flows of gold, which reflect payments disequilibria, cause changes in money supplies which automatically eliminate the disequilibria. Thus in a deficit country the domestic money supply falls as gold flows out to finance the deficit. Prices fall and the deficit is eliminated.Google Scholar
  4. 4.
    See J. Tinbergen, On the Theory of Economic Policy (Amsterdam: North Holland, 1952).Google Scholar
  5. 5.
    See R. A. Mundell, ‘The Appropriate Use of Monetary and Fiscal Policy for Internal and External Stability’, IMF Staff Papers, 1962.Google Scholar
  6. 6.
    Again most conventional textbooks in macroeconomics have a section on the balanced budget multiplier theorem. Resting as it does on a series of restrictive assumptions, the theorem shows that if government expenditure and taxation are raised by the same amount, national income will increase by an amount equal to the increase in government expenditure. Furthermore, it has been suggested that indirect taxes have a greater deflationary effect than equal yielding direct taxes, since direct taxes may be partially offset by a fall in saving while indirect taxes will not be, and because indirect taxes tend to increase the price level and reduce the real supply of money.Google Scholar
  7. 7.
    A model which attempts to allow for cost inflation is discussed in the Appendix to this chapter.Google Scholar
  8. 8.
    Readers may wish to note at this stage that these conclusions change if LM is drawn steeper than BP implying a relatively higher degree of capital mobility. Here contractionary monetary policy will restore payments equilibrium at some cost in terms of unemployment. But contractionary fiscal policy will only widen the payments deficit. Those sufficiently interested may confirm this by redrawing Figure 6.4 for themselves. We return to the question of different degrees of capital mobility later in the chapter.Google Scholar
  9. 9.
    Criticisms of IS-LM range from a relatively minor debate over the values of certain elasticities or the specification of underlying functional relationships to a fairly root and branch rejection of the entire framework. For an example of the latter, which certainly warns us against an unwary acceptance of the IS-LM framework, see Wynne Godley and Francis Cripps, Macroeconomics (Oxford: Fontana, 1983). The final chapter of their book provides an interesting treatment of the open economy, which may be contrasted with the one adopted here.Google Scholar
  10. 10.
    Again most standard macroeconomics textbooks contain an analysis of aggregate demand and supply schedules.Google Scholar
  11. 11.
    See Trevor W. Swan, ‘Longer Run Problems of the Balance of Payments’, in R. E. Caves and H. G. Johnson (eds) Readings in International Economics, (London: Allen & Unwin, 1968).Google Scholar
  12. 12.
    See J. S. H. Hunter, ‘A Technique for Assessing Appropriate Policy Combinations to Combat Inflation, Unemployment and External Imbalance’, Weltwirtschaftliches Archiv, Band 108, 1972.Google Scholar

Copyright information

© Graham Bird 1987

Authors and Affiliations

  • Graham Bird
    • 1
  1. 1.University of SurreyUK

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