Exchange-Rate Management and Policy
In the previous chapter we focused on the analysis of monetary and fiscal policy. Exchange-rate variations came in to the analysis as a fairly passive response to payments disequilibria. In this chapter we concentrate more exclusively on the effects of changing the exchange rate. This will involve discussing the so-called elasticities approach to the balance of payments. This approach contrasts with the open-economy model introduced in Chapter 2 since, whereas that model essentially examines the implications of changes in income with prices held constant, the elasticities approach examines what happens when prices change and income is held constant. The chapter also examines devaluation within the context of the absorption approach which stresses the importance of income as opposed to prices.
KeywordsExchange Rate Foreign Exchange Price Elasticity Supply Curve Foreign Exchange Market
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Notes and References
- 1.The issues raised here can be presented in a more rigorous fashion mathematically. Many books provide just such an analysis of the so-called Marshall-Lerner conditions for successful devaluation. See, for example, John Williamson, The Open Economy and the World Economy, (New York: Basic Books, 1983)Google Scholar
- A. P. Thirlwall, Balance of Payments Theory, 3rd edn (London: Macmillan, 1986)Google Scholar
- Anne Krueger, Exchange Rate Determination (Cambridge: Cambridge University Press, 1983).Google Scholar
- 2.For a review of the evidence as it applies to developing countries, see Graham Bird, ‘Should Developing Countries Use Currency Depreciation as a Tool of Balance of Payments Adjustment? A Review of the Theory and Evidence and a Guide for the Policy Maker’, Journal of Development Studies, July 1983.Google Scholar
- 3.For a treatment which emphasises the importance of income elasticities, see Thirlwall, Balance of Payments Theory.Google Scholar
- 4.For a discussion of the commercial banks’ approach to assessing creditworthiness, see Graham Bird, ‘New Approaches to Country Risk Analysis’, Lloyds Bank Review, October, 1986.Google Scholar
- 5.If such trade-offs do not exist and unemployment is at its ‘natural’ rate, the unification of inflation rates implied by exchange-rate union involves no long-term unemployment cost. There may, however, still be adjustment costs, as well as costs in terms of having to accept a particular unified rate of inflation that would otherwise not be chosen.Google Scholar
- 6.It should be noted that characteristics which impede the effectiveness of devaluation as an adjustment instrument may also impede the effectiveness of other adjustment instruments.Google Scholar