Short-term, or Cyclical, Disequilibria
The previous chapter described a number of important conditions that had to be satisfied if an internationally integrated economy was to enjoy long-term, or fundamental, equilibrium. This does not mean, of course, that such an economy will never experience temporary disequilibria. In fact, there are good cyclical reasons why it may be unable to reconcile internal and external balances in the short run. Some of the most important cases of this kind, together with the policy responses needed to correct them, are described briefly in this chapter.
KeywordsExcess Demand Full Employment External Balance External Imbalance International Transmission
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Notes and References
- 1.The exact magnitude of the impact will depend on the respective sizes of the two countries. This qualification will be ignored, however, in the analysis that follows because it does not alter the conclusion.Google Scholar
- 2.The analysis in the remainder of this section represents a geometric illustration of the multiplier process with foreign trade repercussions. Algebraic derivations of equilibrium under these conditions are available in every modern textbook on international trade.Google Scholar
- 3.Two options are open to B here. First, it can devalue its currency. If the relevant trade elasticities are high enough, this will reduce its imports and increase its exports, helping to restore the internal and external balances. But this would exacerbate the economic contraction in A, as its exports would fall and imports rise. Anticipating this, it is very likely that A would also devalue its currency in order to re-establish the initial parity. There has been no change, after all, in A’s policy objectives: its recession and external surplus are unanticipated, not planned. With A’s devaluation, the two countries would be back where they started, with the problem which prompted B’s action still unresolved. In addition — and this could be very serious — the exchange rate changes would almost certainly destroy confidence in the existing international financial order based on fixed parities. The result would be constant flights of capital between A and B (for precautionary and speculative reasons) in response to purely temporary changes either in actual economic developments and policies or in expectation of such developments. Second, B could impose import controls. However, as this would increase deflationary tendencies in A, it would almost certainly retaliate again. The result would be a reduction in the international division of labour, forcing both countries to restructure their economies accordingly. A short-term, cyclical, problem would be turned, in this case, into a long-term, structural, one of the kind analysed in the next chapter. That is why a prompt action by A is essential here to reconcile internal and external balances in both countries.Google Scholar
- 4.See, for instance, estimates of the relevant elasticities in Magee (1975), and Artus and Young (1979).Google Scholar