A General Equilibrium Analysis of Foreign Exchange Shortages in a Developing Economy

An acute shortage of foreign exchange has been a recurring problem for many developing economies. In the development planning literature, the problem is usually discussed within the framework of the ‘two-gap’ or ‘multi-gap’ models developed and elaborated during the sixties. These models assume fixed input–output coefficients and limited possibilities for export expansion. As a result, a foreign exchange shortage becomes an almost absolute constraint on growth in that even if domestic savings were available in sufficient amounts to allow an increase in investment, the absence of the required complementary foreign exchange makes such an increase impossible. The neoclassical answer to this ‘structuralist’ view has always been to stress the role of relative prices and, in particular, exchange rate adjustment as a means of overcoming any foreign exchange shortage. Stated simply, this view treats the alleged foreign exchange gap as only reflecting an overvalued real exchange rate. If the exchange rate is allowed to clear the foreign exchange market, there can be no foreign exchange gap…(This abstract was borrowed from another version of this item.)