Beggar‐Thy‐Neighbour Exchange Rate Regime Misadvice from Misapplications of Mundell (1961) and the Remedy

Abstract

Economists invoke Mundell (1961) in arguing for the general policy of a flexible exchange rate regime as a means of restoring equilibria after shocks. But there is a discrepancy between the intent of the general policy and attempts at its implementation as identified by specific changes in exchange rates. When we assemble the set of specific changes called for by distinct economists operating as advocates for individual countries, these are uniformly in the form of beggar‐thy‐neighbour advice – i.e. travesties of objectively identifying disequilibria and a menace to international cooperation and peace. This paper traces the unintended travesties to problems of complexity and uncertainty, problems that implicitly are assumed absent in Mundell (1961) rendering the situation so simple that equilibria are transparent. The problems remained essentially unaddressed when economists extended Mundell (1961) via expected utility theory since this theory also ignores the impossibility of maximising and the complexities of central bankers, private firms and others in doing the evaluation stage in reaching decisions. The problems can be overcome by modelling within SKAT, the Stages of Knowledge Ahead Theory. This paper points to experimental evidence in support of the view that under all sorts of disequilibrating shocks, currency unions outperform flexible currencies by eliminating the inefficiencies generated by exchange rate uncertainty.

Managed Floats to Damp World-Wide Exchange Rate Liquidity Shocks Like 1982-5, 2006-9: Field and Laboratory Evidence for the Benefits of a Single World Currency

“…This would only occur if analysts can discern equilibrium under the conditions of complex reality as distinct from the simple worlds postulated in tractable algebraic models. Evidence of inability to discern such real world equilibria is inferable from the systematic biases that economists exhibit when claiming that they have done so [16] and Appendix 3 below, and from laboratory experimental evidence that players failed to recognize that the economy had been in equilibrium, Parts 12 and 13 below.…”

“…The causes and effects of financial crises are not integrally connected to the chaos of unpredictable exchange rate changes. 7 Indeed in sense it is even more encyclopaedic in that it includes interpretations of some econometric results through its lens -something infeasible for the original edition of foundations written when perhaps in that pre-computer age, the only econometric estimates available were those of Holland's Jan Tinbergen and Australia's Trevor Swan [16].…”

“…Instead, as documented in [16], the practice of dirty floats has been systematically of a beggar-thy-neighbour form, Appendix 3.…”

“…16 16 After encountering a problem, there can be a vast number of stages as new things are learned, almost minute-by-minute. The reduction to only four epistemic stages in Table 1 and Figure 2 is because these portray the simple case where: i) each change in knowledge is from ignorance about some future happening -i.e.…”

“…Indeed depreciations can perversely so increase the import bill that the current account worsens. 35 On the beggar-thy-neighbour bias in how the Meadian concept of equilibrium is in practice applied by advocates of exchange rate changes, see Appendix 3 and [16].…”