Competitive devaluations: toward a welfare-based approach

This paper revisits the international transmission of exchange rate shocks in a multicountry economy, providing a choice-theoretic framework for the policy analysis of competitive devaluations. As opposed to the traditional view, a devaluation by one country does not necessarily have an adverse beggar-thy-neighbor effect on its trading partners, because they can benefit from an improvement in their terms of trade. Furthermore, a retaliatory devaluation need not be the optimal strategy for the neighbor countries, as the induced terms of trade deterioration can be large enough to offset the gains from defending their export market share. The concern over competitive devaluations reflected in the Fund's charter, and the system-wide implications of changes in exchange rates, still motivate Fund policy recommendations. A major Fund concern in the Asian crisis has been the fear that Asian currencies would become so undervalued and current account surpluses so large as to damage the economies of other countries, developing countries included. This is one reason the Fund has stressed the need first to stabilize and then to strengthen exchange rates in the Asian countries now in crisis - and for this purpose, not to cut interest rates until the currency stabilizes and begins to appreciate.


Publication year:
2000
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In: Journal of international economics. - Amsterdam. - Vol. 51(2000), Issue 1, p. 217-241
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