Quotas v. Devaluation in the Small Open Economy

Abstract

Only one attempt has been made in the existing literature to evaluate the validity of the claim that quotas are less inflationary than devaluation. Cornes and Dixit (1982) contrast the impact of the two policies upon the price of non-tradables in a static three-sector model (importables, exportables and non-tradables) of the small open economy in which free trade prevails initially and nominal money balances enter the private utility function. After showing that the price of the non-traded good may rise more or less under the quota that produces the same improvement in the trade balance as devaluation, they conclude that the issue as to which instrument is more 'inflationary' can only be resolved empirically. In this paper I take up the issue in an optimizing perfect-foresight model of the small open economy that differs in a number of important respects from the model of Cornes and Dixit. The time horizon is longer, extending beyond the short run to encompass the entire transition path for domestic prices; real, (?) The London School of Economics and Political Science 1993