Re: Trade policy

["Leigh Harkness" <Leigh@xxxxxxxxxxxxxxxxxxxx>]

Paul

You wrote:

> WHO IS THIS "WE" THAT KNOWS THIE FLEXIBLE EXCHANGE RATE ASYSTEM TO BE THE
> "BETTER SYSTEM".
>
> THE "WE" CAN NOT INCLUDE KEYNES NOR MYSELF.
>
>   AND IF YOU UNDERSTOOD THE MARSHALL-LERNER CONDITION REGARDING TRADE IS
> NOT LIKELY TO BE EFFECTIVE IN THE SHORT RUN  -- AND THAT FREE CAPITAL
FLOWS
> CAN BE HORRIBLY DISTRUCTIVE UNDER A FLEXIBLE EXCHANGE RATE SYSTEM -- YOU
> TOO MIGHT OPT-OUT OF THIS "WE" GROUP.


I was hoping someone would bite on this issue.

I agree that the floating exchange rate system is not a better system.
However, I find some flaws in the fixed exchange rate system.  That is why I
have been exploring other systems, such as optimising systems.

I do not accept the Marshall-Lerner conditions.  The the trade balance, or
more specifically, the current account balance is not driven by the exchange
rate.  The current account deficit is a caused by excess demand (that is
total demand in the economy) and excess demand is not a function of the
exchange rate and it has nothing to do with elasticities.


That is,
> >when countries succeed at raising our exports, they must increase imports
> >simultaneously, by the same amount.  This is achieved through the
exchange
> >rate system.  The value of the currency rises to make imports cheaper, so
> >that domestic consumer buy more.
>
>
> Obviously you are assuming the Marshall-Lerner condition is universally
> applicable.

The floating exchange rate system requires that international receipts and
payments must be equal.  That is why the exchange rate moves under the
floating exchange rate system.

If exports grow and thereby raise the demand for domestic currency on the
foreign exchange market, the supply of domestic funds on the foreign
exchange market can be met by increased imports or by increased capital
flows overseas.  But in the overall balance, imports (of goods and services)
have to increase.   Under floating exchange rates, the net capital flows has
to equal the net current account deficit and the current account deficit has
to equal the excess demand (that is expenditure greater than income).
Raising income through increased exports does not affect the factors that
finance expenditure to be greater than income.


> >The higher value of the currency has two effects: it not only makes
imports
> >cheaper; it reduces the incomes of exporters.


>   if the demand for there exports is inelastic--  then what happens to the
> income of exporters?

If the demand for imports were inelastic, the higher exchange rate would
still reduce the income of exporters.

Leigh