Consumers' Behaviour and the Conditions for Exchange Stability

Abstract

The proposition that the exchange rate will be stable if the sum of the elasticities of import demand of the home and foreign ( rest of the world ) country respectively exceeds unity, rests on the following assumptions: (a) that each country's elasticity of aggregate supply is infinite and that its output contains no import component, so that imports consist of final goods only; (b) that trade is initially balanced; (c) that, for any given national money income, aggregate money expenditure remains constant irrespective of price changes. Other assumptions, which are usually taken for granted, are those of a constant budget surplus, constant money wages, a neutral influence of income redistribution on the parameters of the consumption function, and a perfectly elastic supply of money (bonds), making for a credit system which performs no independent restrictive function. One can drop one or more of these restrictive assumptions and examine the consequences. In recent years the fashion has been either to drop the whole lot-in the process, however, throwing overboard, into a vast sea of coefficients, the baby as well as the bathwater-or, when the dropping was selective, to jettison assumption (c) while retaining all the others. This paper falls exclusively in the latter category, and encompasses, therefore, within its purview only four writings out of the vast literature on exchange stability: those of A. C. Harberger,' S. Laursen and L. A. Metzler,2 W. F. Stolper3, and A. C. L. Day.4 Except for one or two passing references to the variation of investment outlays, all these writings allow only for changes in consumption expenditure. The dropping of assumption (c) affects, therefore, the consumption component of aggregate expenditure, but not the investment component. In fact, to ensure rigorous consistency, it is necessary to assume not only that investment outlays are constant, but also that they are confined to domestic goods, whose prices [by assumption (a)] do not change, so that the volume of investment is constant too. The plan of this paper is to set out the relationship between the various conditions for exchange stability formulated by the above