Effects of a Devaluation on a Trade Balance

Abstract

T HE CONVENTIONAL ANSWER to the question, what is the effect of a devaluation on the trade balance of the devaluing country, runs in terms of the supply and demand conditions in the devaluing country and in the rest of the world. It is presumed that the devaluation initially tends to reduce the foreign prices of the country's exports in proportion to the devaluation. At these reduced prices, foreign demand for the country's exports will be increased, thus tending to bid up the foreign prices of these exports part-way back toward their predevaluation levels. How much the foreign currency proceeds of the country's exports will change then depends upon the elasticity of foreign demand for the country's exports and the elasticity of domestic supply of export goods. Similarly, on the import side, the initial effect of the devaluation is to raise the domestic price of imports, presumably leading to some reduction in the country's demand for imports, which in turn may tend to reduce the world price of the imported goods. The size of these reactions on imports depends upon the elasticity of domestic demand for imports and the elasticity of foreign supply of imports. The effect of the devaluation on the foreign trade balance can accordingly be expressed in a formula which involves principally the four elasticities mentioned above.' In the present paper, it is suggested that a more fruitful line of approach can be based on a concentration on the relationships of real expenditure to real income and on the relationships of both of these to the price levels, rather than on the more traditional supply and demand analysis.