The Policy Mix in the Open Economy

  • J. O. N. Perkins


In the preceding chapters we have considered the principles on which decisions should be made about the best policy mix to minimise inflation whilst maintaining a high level of activity, within the context of a closed economy. This economy may be thought of as the world as a whole, or as a first approximation to the relevant prescription for an individual country, especially a large one. But we have now to ask how the analysis has to be modified to take into account the qualifications and complications that arise when the country whose policy decisions we are considering has transactions with countries in the outside world, the governments of which it cannot control and which it will usually not be able to influence to any appreciable extent. A very large country may reasonably feel it appropriate to assume that its own actions influence the actions of other governments to some extent, and that its actions have an appreciable effect on economic events in the outside world; and also that these outside actions and events then react back on itself. The greater the extent to which it needs to take account of such repercussions as these, the closer will its position be to that of a closed economy; and the less need will there be to qualify the analysis of the preceding chapters. But most countries (probably all countries apart from the USA, and in some contexts West Germany and Japan) have to be regarded as ‘small’ in the sense that their policy decisions will not normally have an appreciable effect on the rest of the world; or not to such an extent that any repercussions will then react back on them in a manner that normally needs to be taken into account in forming their policies. It is the policies of ‘small’ countries in this sense that are beine discussed in this chapter.1


Exchange Rate Interest Rate Monetary Policy Price Level Current Account 
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Notes and references

  1. 1.
    I am indebted to David Vines for saving me from several errors in this chapter.Google Scholar
  2. 2.
    It is important always to consider the effects of exchange rate changes in terms of foreign exchange (and also in terms of their real effects on domestic activity or employment). For if the unit employed is the currency of the devaluing country itself, this is in effect using a measuring rod that is itself changing in size as a result of the devaluation. In other words, if there were no real change as a result of the devaluation, a calculation in terms of the devaluing currency would show rises in both imports and exports, and a rise in the deficit (if there were a deficit initially). It is essential to separate this ‘measuring rod’ effect from the matters of real interest—which are the effects on the country’s reserves and on its level of employment. Discussion and calculations of the effects of exchange rate changes should therefore be in terms of some major currency whose parity against the average of other currencies has not changed appreciably, or, preferably, in terms of some weighted average of currencies (such as the SDR (Special Drawing Rights) unit of the International Monetary Fund). Alternatively, the calculation might be in terms of the predevaluation (or preappreciation) value of the currency whose parity had altered; thus a ten per cent rise in the reserves, or deficit (as normally measured in its own currency) would represent no real change after a ten per cent devaluation.Google Scholar
  3. 3.
    See Marina v. N. Whitman, ‘Global Monetarism and the Monetary Approach to the Balance of Payments’, Brookings Papers in Economic Activity (December 1975).Google Scholar
  4. 4.
    It is also likely to give excessive protection to those industries that are most obviously competitive with imports, such as manufacturers, and relatively inadequate assistance to industries such as live entertainment, which on the face of it appear to be ‘non-traded’ items.Google Scholar
  5. 5.
    For an algebraic formulation of these principles, see Appendix 2.Google Scholar
  6. 6.
    For a survey of recent literature on this subject see Dale W. Henderson, ‘Modeling the Interdependence of National Money and Capital Markets’, American Economic Review; Papers and Proceedings (February 1977).Google Scholar
  7. 7.
    See Rudiger Dornbusch and Paul Krugman, ‘Flexible Exchange Rates in the Short Run’, Brookings Papers in Economic Activity, 3 (1976).Google Scholar

Copyright information

© J. O. N. Perkins 1979

Authors and Affiliations

  • J. O. N. Perkins
    • 1
  1. 1.University of MelbourneAustralia

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