Skip to main content

Balance of Payments Adjustment and the Euro Crisis

It is worth remembering that according to Eichengreen (1996, p. 25) “the most influential formalization of the gold-standard is the price-specie flow model of David Hume. Perhaps the most remarkable feature of this model is its durability: developed in the eighteenth century, it remains the dominant approach to thinking about the gold standard” (for a critique go here).

The idea is that, at least in a fixed exchange rate regime, inflation and deflation do all the work of adjusting the balance of payments (BOPs). Modern versions add credibility and all that (which includes austerity) for the stabilizing flows of capital to work. Why do I bring this up? Because of Martin Wolf's column (subscription required) in the Financial Times today, which has the graph below.

Note that the countries in crisis, Greece, Ireland, Italy, Portugal and Spain have already adjusted their BOPs (in this case their trade balances). Yet the adjustment is more Keynesian than Humean, or to be more precise, it follows the analysis of A.G. Ford, who argued that peripheral countries, like Argentina, adjust their current account deficits with a good old recession not by lowering domestic prices. And yes, Wolf is right, the specie-flow would only work in a parallel universe.

Comments

  1. Hume's price-specie-flow mechanism assumes that money is neutral, and the logical extension is The Theory of Purchasing Power Parity (PPP), which states that long-run real exchange rates between countries are in equilibrium when the purchasing power of one nation’s currency is the same as the nation for which it trades with. The implication is that the process of international trade is that of arbitrage, that is, long-run real exchange rates between two currencies over any period of time are determined by changes in relative prices. In this sense, if nations have similar consumption and output baskets, in the long run, the exchange rates lead to common-currency price levels that are equal to a constant stationary mean, which implies that over a significant period of time, any standard commodity that is traded should sell for a similar price no matter where it is located in geographical space, once factors such as transportation costs, tariffs, and taxes are accounted for. Whatever the monetary or real disturbances in the capitalist world economy, because of 'transaction costs', the prices of a common basket of goods in will generally be the same at all times.

    The presupposition is that if one abstracts from various sources of capital flows and strategic government interventions in the foreign exchange market, the exchange rates will move in such a fashion as to reflect the relative price levels of the trading partners domestic economies. That is, the theory of Purchasing Power Parity (PPP) is a special case of the comparative advantage hypothesis known as the Law of One Price (LOOP); that is, long run real exchange rates move in such fashion as to automatically balance trade between freely trading nations, regardless of the differences in their levels of development or technology.

    #conventionaldogma

    ReplyDelete

Post a Comment

Popular posts from this blog

What is the 'Classical Dichotomy'?

A few brief comments on Brexit and the postmortem of the European Union

Another end of the world is possible
There will be a lot of postmortems for the European Union (EU) after Brexit. Many will suggest that this was a victory against the neoliberal policies of the European Union. See, for example, the first three paragraphs of Paul Mason's column here. And it is true, large contingents of working class people, that have suffered with 'free-market' economics, voted for leaving the union. The union, rightly or wrongly, has been seen as undemocratic and responsible for the economics woes of Europe.

The problem is that while it is true that the EU leaders have been part of the problem and have pursued the neoliberal policies within the framework of the union, sometimes with treaties like the Fiscal Compact, it is far from clear that Brexit and the possible demise of the union, if the fever spreads to France, Germany and other countries with their populations demanding their own referenda, will lead to the abandonment of neoliberal policies. Aust…

A brief note on Venezuela and the turn to the right in Latin America

So besides the coup in Brazil (which was all but confirmed by the last revelations, if you had any doubts), and the electoral victory of Macri in Argentina, the crisis in Venezuela is reaching a critical level, and it would not be surprising if the Maduro administration is recalled, even though right now the referendum is not scheduled yet.

The economy in Venezuela has collapsed (GDP has fallen by about 14% or so in the last two years), inflation has accelerated (to three digit levels; 450% or so according to the IMF), there are shortages of essential goods, recurrent energy blackouts, and all of these aggravated by persistent violence. Contrary to what the press suggests, these events are not new or specific to left of center governments. Similar events occurred in the late 1980s, in the infamous Caracazo, when the fall in oil prices caused an external crisis, inflation, and food shortages, which eventually, after the announcement of a neoliberal economic package that included the i…