TheWelfare Effects of Restrictions on U. S. TradeRECENT ECONOMIC AND POLICY DEVELOPMENTS in the areas of stabilization, allocation, and distribution' help explain the current political mood in some parts of the United States in favor of greater protectionism.In the area of macroeconomic stabilization, anti-inflationary policies in 1968-71 led to an undesirably high rate of unemployment. For a number of reasons, these had only limited success in reducing the rate of inflation at the hoped-for speed; the result was the price controls imposed on August 15, 1971. The inflation, an increasingly overvalued dollar, and business cycle developments here and abroad placed pressure on both our * I am grateful to Robert Z.
Global Mone tar/sn and the Monetary Approach t o t he Balance of PaymentsA DECADE OR SO ago, when the twin concerns about the balance of payments of the United States and the functioning of the international monetary system began to impinge on the consciousness of a public theretofore indifferent to such esoterica, the opinions of those who were already paying attention fell into a neat dichotomy. Government officials and "men of affairs," on the one hand, insisted that the continued health of international trade, investment, and the world economy required the maintenance of the Bretton Woods system of pegged exchange rates, under which changes in rates were made infrequently and as a last resort. Academic experts, on the other hand, were nearly unanimous in pressing the advantages of greater flexibility of exchange rates, with many urging that governments abstain altogether from intervention and allow exchange rates to be determined by the interplay of supply and demand in the market-This paper was supported partially by financial assistance from the Departments of State, Treasury, and Labor under Contract No. 1722-520176. However, the views contained herein are solely the author's and do not necessarily represent the official position of the U.S. government. I am grateful to Edmond Alphandery, Rudiger Dornbusch, Jacob A. Frenkel, Peter B. Kenen, Norman C. Miller, and to the discussants and members of the Brookings panel for their helpful suggestions.491 sent a return to a tradition far older than the Keynesian approach they are challenging-to the price-specie-flow mechanism of David Hume, who argued that the international flows of reserves engendered by a payments imbalance would, through their effects on national money supplies and price levels and thus on the trade balance, automatically restore external balance.6 Nonetheless, these views pose a direct challenge to the current orthodoxy, and they have revolutionary implications for balance-of-payments policy and even for balance-of-payments accounting. The Skeleton Model: A Tripartite StructureTo assess these implications, and evaluate the relative merits of the Keynesian and the global-monetarist prescriptions for contemporary U.S. policy, requires first describing the analytical underpinnings of this new-old approach and ascertaining where it can, and cannot, be reconciled with current orthodoxy.7 These tasks, in turn, call for an examination of the various, frequently intertwined, intellectual strands that together give the pp. 31-52. The economists referred to in the title are Robert Mundell and Arthur Laffer, two leading proponents of global monetarism. The modern incarnation of global monetarism was developed during the late 1950s and 1960s, primarily in a series of articles by Mundell, many of which are collected or further developed in two books by him:
Import Prices i n t he Currency-Contract Period EVENTS IN INTERNATIONAL MONEY MARKETS since 1971 have aroused considerable interest in the effects of changes in foreign exchange rates on trade patterns. In any theoretical approach, the prices of traded goods are crucial to economic activity following devaluation. Because the quantities of exports and imports may be inflexible for a time following a devaluation, price changes determine the movement in the trade balance in the short run. "Currency-contract analysis" deals with the first round, or impact, effect of devaluation on the prices of internationally traded goods that cross national boundaries after devaluation but that were contracted for before it took place.' The crucial determinant of this effect on the trade balance is whether these contracts are denominated in home currency or in foreign currency. My earlier paper in this journal stressed that the initial decline in the trade balance that countries sometimes experience following devaluation Note: I am indebted to the Rockfeller Foundation and the National Science Foundation for research support; to
national financial capital flows-movements of nondirect investment items in the capital account-related capitalfiows to levels of interest differentials. According to this "flow theory," an increase in foreign short-term interest rates would increase the outflow of capital from the United States, and as long as foreign interest rates remained higher than American rates, the flow would continue. Conversely, one way for the United States to improve its balance on capital account would be to raise its rates, and as long as U.S. rates remained higher than foreign rates, the capital account would show a reduced deficit. This relationship of capital flows to levels of interest rates was rather widely accepted in the mid-1960s by both theorists and empiricists in international economics. For example, the famous articles by Robert A. Mundell on the simultaneous maintenance of external and internal balance generally assumed the relationship: ".. . at high rates of interest the net inflow of capital will be larger, or the net outflow will be smaller, than at low rates of interest."' In a well-known study, Peter B. Kenen also cor-235 * I wish to acknowledge, in addition to assistance from participants in the Brookings panel, the comments of Burton Malkiel, assistance from Raymond D. Hill in all aspects of preparation, and support from National Science Foundation Research Grant Number GS, 1972.
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