Adjustment in the World Economy
There is a widespread view that world payments imbalances can be remedied through increased demand in surplus countries and reduced demand in deficit countries, without any need for real exchange rate changes. In fact shifts in demand and real exchange rate adjustment are necessary couplets, not substitutes. The essential reason for this complementarity is that a much higher fraction of a marginal dollar of US than of foreign spending falls on US output. As a result, a redistribution of world spending away from the US leads to an excess supply of US goods unless accompanied by a decline in their relative price. Although some economists believe that the integration of world capital markets somehow eliminates this problem, this is a fallacy that confuses accounting identities with behavior. The paper also addresses a number of relates issues, such as the role of budget deficits in determining domestic demand and the effectiveness of nominal exchange rates changes in producing real depreciation.
|Date of creation:||Oct 1987|
|Date of revision:|
|Publication status:||published as Krugman, Paul "Adjustment in the World Economy." GROUP OF THIRTY OCCASION AL PAPERS, No. 24, (1987), pp. 1-40.|
|Contact details of provider:|| Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.|
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"Domestic Saving and International Capital Flows,"
Royal Economic Society, vol. 90(358), pages 314-29, June.
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Federal Reserve Bank of Kansas City, pages 103-155.
- Goldstein, Morris & Khan, Mohsin S., 1985. "Income and price effects in foreign trade," Handbook of International Economics, in: R. W. Jones & P. B. Kenen (ed.), Handbook of International Economics, edition 1, volume 2, chapter 20, pages 1041-1105 Elsevier.
- Olivier J. Blanchard & Lawrence H. Summers, 1984. "Perspectives on High World Real Interest Rates," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 15(2), pages 273-334.
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