Devaluation, Non-Flexible Prices, and the Trade Balance for a Small Country: Comment

Abstract

In a recent article in this JOURNAL, Jones and Corden ( 1976, hereafter referred to as i-c) examine the impact of a devaluation on the trade balance of a 'small' country under varying assumptions about the accompanying government policies for internal balance. While I strongly support the basic thrust of the analysis, namely that since the balance of payments is but one in a set of simultaneous equations any investigation of the impact of a devaluation must include a treatment of coincident government policies, I feel that the conceptual framework employed cannot be supported on either theoretical or empirical grounds, so that their conclusions are potentially misleading. In this comment I discuss the inherent problems of their conceptual framework and offer an alternative paradigm for investigating the quiestions under consideration.1 The basic assumption of J-c, that the government implements fiscal policy to insure internal balance, implies of course that, in the absence of active government policy, rigidities of some type would prevent markets from clearing. Yet for the most part they do not specify the underlying rigidities but simply discuss various possible targets of internal balance without questioning the economic rationale of these targets. In particular, J-C assume that government policy sees to it that either the non-traded good price or the nominal wage rate is pegged at some exogenous level by ensuring that excess demand (supply) never develops. Of course this type of policy is only necessary and hence defensible if, in the absence of government policy, non-governmental rigidities would prevent (say) the wage rate from declining in the face of excess supply and would thereby generate unemployment. In other words their policy