The Monetary Determinants of Real Trade

Abstract

In standard trade theory, whether of the static Heckscher-Ohlin kind or of the dynamic Oniki-Uzawa-Inada kind, the pattern of trade is determined by the preferences, technology and factor endowments of the trading partners, and by the social contrivances of taxes and subsidies. The role of other contrivances has been neglected. In particular this is true of the stock of fiat money and of its rate of change in each of the trading countries. The rate of domestic monetary expansion or contraction determines the rate of change of the domestic price level; hence the relative attractiveness of physical assets and money as repositories for savings; hence the relative demands for consumption and investment goods; hence the relative excess or import-export demands for those goods. In fact, the rate of monetary expansion determines not merely the extent of trade in each class of goods but also its direction. Given the rate of monetary expansion in the rest of the world, and subject to certain qualifications, there exists a rate of expansion that is critical in the sense that at lower rates of expansion one commodity is exported and at higher rates, the other commodity. This critical rate will be called the 'switching rate. My purpose in the present note is to set out the foregoing argument in detail, with all assumptions and qualifications made explicit, and to show how the switching rate of domestic monetary expansions responds to changes in the rate of monetary expansion abroad and to changes in the domestic rates of saving and population growth. The analysis is of the comparative steady-states variety and relates to a small country with no influence on world commodity prices.