flexible exchange rates

[pdavidso <pdavidso@xxxxxxx>]

WARREN:

I think part of our communication problem is that you do not fully understand
the implcation of not having the Marshall-Lerner condition apply for a country
with a flexible exchange rate -- when that country is having a problem with
its balance of payments.

Suppose a nation is running an import surplus which you maintain is a good
thing since the nation's residents are receiving real goods (imports) in
excess of the cost of real goods (exports) it is selling to foreigners. In a
flexible exchange rate system, this will cause a tendency for this importing
nation to have its exchange rate to decline. If the Marshall - Lerner
condition does not hold, then the effect will be:

(1) EXPORTS WILL BECOME CHEAPER TO FOREIGNERS SO THAT REAL EXPORT GOODS (IN
TERMS OF PHYSICAL VOLUME) WILL INCREASE BUT--- the actual revenue received by
the exporters WILL DECLINE,

AND/OR

(2) REAL IMPORTS WILL BECOME MORE EXPENSIVE TO DOMESTIC RESIDENTS AND
THEREFORE REAL IMPORT GOODS (IN TERMS OF PHYSICAL VOLUME) WILL DECLINE BUT---
DOMESTIC RESIDENTS WILL PAY OUT MORE OF THEIR INCOME FOR FEWER REAL IMPORTS!!

THus, in your own terms of imports being a good thing for the nation and
exports being a real cost for the nation, a flexible exchange rate in the
absence of the Marshall -Lerner condition is like to reduces the good (import
volume) of the nation and/or increasing the costs (exports).

And with a flexible exchange rate as long as the Marshall-Lerner condition
does not apply, this will force the nation's exchange rate to decline further
-- increasing the real costs (exports) and/or reducing the benefits (imports)
until the either the Marshall Lerner condition comes into affect -ending this
process of fuirther nation impoverishment -- or the nation's economy becomes
so impoverished it collapses.

And as long as the Marshall - Lerner condition does not apply, the exchange
rate will continue to decline, and therefore (1) and (2) above will continue
to reduce the good for the nation and increase the costs.

So a flexible exchange rate in this case reduces the good thing (i.e., the
volume of imports) for the nation and increases the costs (exports) -- where
good thing and costs are defined by you!!

So what is so desireable about a flexible exchange rate? Especially when the
empirical evidence is that the Marshall -Lerner condition does not apply for
most nations in the real world??


If you want to read about the Marshall -Lerner condition see pages 215-219 of
my book POST KEYNESIAN MACROECONOMIC THEORY (1994)


Secondly, Keynes analysis was not for the Gold standard or even rigidly fixed
exchange rates. Keynes's analysis permitted exchange rates to change --if the
change reflected changes in the relative real wage (real costs of production)
between the trading partners.

Regarding advocates for flexible exchange rates -- I think you will agree that
Milton Friedman is one of the most articulate proponent of flexible exchange
rates. Yet in a debate with me in the JOURNAL OF POLITICAL ECONOMY (1972) --
later (1974) published as a book entitled MILTON FRIEDMAN'S MONETARY
FRAMEWORK: A DEBATE WITH HIS CRITICS (University of Chicago Press) -- Friedman
argued that flexible exchange rates are desireable -- as ling as the exchange
rates are stable over time -- for "violent instability in terms of a specific
money would reduce the usefulness of that money".

So flexible exchange rates are OK as long as they do not flex too much!!

Paul

Paul Davidson
Editor, Journal of Post Keynesian Economics
University of Tennessee
SMC 503
Knoxville, Tennessee 37996-0550
office phone #;(865)974-3303; office fax#(865)974-4601
home phone and fax # (561)369-1951
email pdavidson@xxxxxxx
http://econ.bus.utk.edu/Davidson.html