When a Country Experiences a Depreciation of Its Currency, It Can Expect Which of These to Happen?

One OF THE main purposes of exchange depreciation in industrial countries is to lower export prices in order to increment the volume of exports. The question is to what extent and nether what conditions exchange depreciation will achieve this objective.

When a country depreciates its currency, the gilded or strange currency equivalent of all its prices is reduced in proportion to the reduction in the value of the currency. Nonetheless, various processes which tend to increase prices in the depreciating country brainstorm to operate immediately after depreciation. These processes will offset partially, or in the limit totally, the consequence of the depreciation. The purposes of this newspaper are to draw these processes of price increases and the factors which determine them, and to find statistical measurements for the extent of the increases and the residual net toll fall in terms of gold.

The extent of the original depreciation is used equally a yardstick against which to measure out the price changes. Accordingly, the effectiveness ⁱ of depreciation is defined as the ratio between the percent internet autumn in cost (in terms of aureate) and the percentage depreciation. If, after depreciation, there is no adjustment whatever of domestic prices in national currency, the effectiveness is equal to unity, or 100 per cent; prices in terms of gold autumn by the total amount of depreciation. If, after depreciation, prices in national currency rise by, for instance, threescore per cent of the amount of depreciation, the effectiveness of that depreciation would be measured every bit approximately² 0.4, or twoscore per cent. If prices in national currency increase by the full amount of depreciation, the effectiveness would be zero.

The effectiveness of depreciation may be studied in relation to diverse sets of prices. In general it will exist found to be smaller for wholesale prices, especially if they include many prices of imported commodities, than for retail prices or the toll of living. In this paper, the effectiveness of depreciation is considered with particular reference to the question of possible improvement of the balance of payments of the depreciating state. On that account it is measured hither in terms of movements in the consign price index.ⁱⁱⁱ

Description of Adjustment Process

The process of cost aligning after commutation depreciation may be conveniently described by reference to Nautical chart 1. Here the curves DD′ and South₁S_one′ depict respectively the need for and the supply of a country'southward exports prior to depreciation. The export toll at the intersection of these 2 curves equals the distance AB. By depreciation the state is then causeless to lower the value of its currency in terms of foreign currencies as indicated on the left side of the chart. The per centum depreciation is equal to $\frac{\mathrm{BC}}{\mathrm{BA}}\times 100$ . The well-nigh immediate result on consign prices is a reduction in the same proportion: as a result of depreciation the export prices in national currency quoted on the 24-hour interval before volition, to foreign buyers, appear to take been lowered in proportion to the depreciation. Prices in terms of gilded fall to AC. The supply curve which in the very short run remains unchanged in terms of national currency moves downward to the position S_iiS₂′ in terms of gold.

Simply at betoken C there is no equilibrium between demand and supply. A new equilibrium is reached at bespeak F where DD′ intersects S_twoSouth₂′ and at a cost level in terms of golden, Atomic number 26, which is college than CA, but lower than BA. This equilibrium position is temporary, however. The supply bend itself volition motility up, for two reasons:

(a) There will be an automatic and prompt increase in the price in national currency of imported raw materials entering into exports. It may exist expected that the domestic price of these imported raw materials will adjust itself virtually immediately and fully in proportion to the depreciation. The rise on this account of the supply curve in terms of gilded above the level Due south₂S_two′ is likely to stand for only a small-scale fraction of its initial fall, depending on the percentage which the value of imported raw materials represents in the value of commodities ex-ported. For countries with very "open" economies, similar those of Western Europe, this percentage may maybe run every bit high every bit xx per cent; for other countries, it will be much less; and for a state similar the United states, it should be almost negligible.

This automatic increase in costs will occur in fully controlled economies, where both the volume and the toll of imports are controlled, and in free economies, where both the volume of imports and their price are adjusted to domestic demand conditions. But in an economy where the volume of imports is controlled by a license organization, etc., but prices of imported commodities are left complimentary to reverberate their scarcity, a ascent of the landed cost of imported commodities upward to the level of prevailing internal prices will more often than not tend to reduce the abnormal profits of importers rather than to increment the prices they charge. This situation probably prevails in many Latin American countries which apply import restrictions but no price controls.

(b) The rise in import prices through the effect on the toll of living on the one mitt, and improved employment atmospheric condition as a result of depreciation on the other mitt, volition tend to raise wage rates. This factor may lead to a very considerable ascension of the supply bend if the depreciating country is at or near total employment, and in particular if the population is strongly aggrandizement-conscious. In the ultimate stage of hyperinflation, wages may actually be stock-still twenty-four hours by twenty-four hours by reference to the rate of exchange; the outcome will be practically the same if wages are fixed on the basis of a cost of living index and if merchants conform their price quotations to fluctuations in the foreign exchange market place. In such a state of affairs, the cost curve will be raised quite speedily by wage and other cost increases to the aforementioned extent that information technology had been lowered past depreciation, and depreciation becomes completely ineffective equally a mensurate to lower prices.

Fifty-fifty without hyperinflation the supply bend will rising considerably if wage rates are fully adjusted for any increase in the cost of living. Any depreciation volition then set in motion a concatenation of adjustments (import prices, cost of living, etc.). Since other incomes, in particular those of rentiers, are not adjusted to price increases, the process of reciprocal adjustment between the cost of living and wage rates will stop short of fully offsetting the effects of depreciation. Nevertheless, the rise of the supply curve in these circumstances volition be considerably in backlog of what might be expected on the basis of the ratio of imports to national income; and the effectiveness of depreciation in reducing prices will exist reduced accordingly.⁴

In the chart a new supply curve Southward₃S₃′ has been fatigued to point the increment from the S_twoS_two′ level on account of the 2 causes mentioned. The upward movement can be measured by the distance CK. A new equilibrium will then establish itself at point H and the equilibrium price will exist AL. The effectiveness of depreciation may then be indicated equally $\frac{\mathrm{LB}}{\mathrm{BC}}$ .

Two further observations must exist made with respect to the process of adjustment. Get-go, if the depreciating land reduces its imports of raw materials, the earth price of these materials in terms of gilt may fall somewhat. Local currency prices will then not rise fully in proportion to the extent of the depreciation; just compared to prices paid by other countries, prices in local currency in the depreciating land will, afterwards depreciation, exist higher exactly in proportion to the extent of the depreciation.

Secondly, depreciation, if effective in improving a country's balance of payments, will exercise a certain deflationary effect abroad, which is the counterpart of its inflationary effect in the depreciating state. The foreign demand bend for the country's exports (DD′) may then exist expected to move somewhat to the left. Since the deflationary influence is probable to be spread all over the world, this shift would by and large not be so big and is disregarded in what follows.

Elasticities of Foreign Demand and Domestic Supply

Information technology follows from the preceding that the price rise subsequent to depreciation may exist considered equally due to (a) factors determining the upward motion of the supply curve (the distance KC in Chart i), and (b) the slopes of the supply and need curves. The conditions affecting (a) have already been discussed. Those affecting (b) will at present exist considered.

Depreciation volition exist the more effective in lowering consign prices, the greater the elasticity of supply of the depreciating state and the smaller the elasticity of foreign demand. The effectiveness will be equal to unity if either the domestic supply for exports is fully elastic or the foreign demand for the country's exports is fully inelastic. Conversely, it will exist equal to zero if either the country'south supply is wholly inelastic or the foreign demand for the country's products is completely elastic. This will be readily verified by imagining different slopes of the supply and need curves in Nautical chart 1.⁵

The predominant factors which make up one's mind the magnitude of the elasticity of foreign demand are the following:

(a) The composition of exports. The more specialized a state'southward exports, the less rubberband volition exist the strange demand since price exchange betwixt its exports and the exports from other countries volition tend to be limited.

(b) The share of the country's exports in total earth merchandise of similar bolt. The elasticity of demand for the commodities sold past an individual supplier in a given market tends to vary inversely with the relative size of that supplier.

(c) The number of competing countries depreciating at the same fourth dimension. This is a special instance of (b). If a number of countries depreciate at the same time, the elasticity of need for the exports of each separately is reduced.

Information technology would follow from the preceding that an industrial country, bulking relatively big in world trade and exporting specialized industrial articles, would experience a relatively large fall in its export prices as a upshot of depreciation. On the other hand, the smaller and less specialized industrial exporter would tend to meet with a smaller pass up. Agricultural countries exporting standardized staples would also tend to experience only a small autumn in their consign prices equally a outcome of depreciation.

Three factors may likewise be listed which determine the elasticity of supply:

(a) The nature of the commodities exported. More often than not, the elasticity of supply of industrial products, the output of which tin can be adjusted in the short run, is greater than the elasticity of supply of agronomical products, except when large stocks of the latter are available.

(b) The proportion of exports to total national output of the bolt exported. Where a modest proportion of the total production of a commodity is exported, a relatively modest rise in price in terms of national currency may free from domestic consumption a quantity which would be large compared with the previous volume of exports of that commodity.

(c) The country of business weather. Generally speaking in conditions of low, when at that place are large stocks and ample unused capacity, the elasticity of supply would exist slap-up. In atmospheric condition of full employment, on the other hand, the supply bend will be steep and, in the limit, where all bolt that could possibly be exported are in fact exported, the elasticity of supply for consign will be zippo, and the effectiveness of depreciation accordingly besides null.

In weather of full employment, which will ofttimes be accompanied by a trend toward aggrandizement, in that location are thus two factors tending to minimize the effectiveness of depreciation: the tendency of the supply curve to ascension by a large proportion of the initial fall caused by depreciation, and the steepness of the supply curve. These 2 factors piece of work in the aforementioned direction, but their furnishings are not cumulative. The more than the supply curve rises, the less increment there is in the quantity exported (compared with the position before depreciation) and there-fore the smaller is the motility along the supply curve. If, in the limiting instance, the supply curve in terms of gold subsequently depreciation moves upward all the way to the position South₁S_one′, there will be no increment in the quantity exported and therefore no influence at all of the slope of the supply curve on the export price.

Statistical Findings

And so far the effect of commutation depreciation has been discussed with reference to the accented price level of one state. Before statistical measurement tin can be considered, it is necessary to laissez passer to relative prices, viz., the consign cost level of the country under consideration compared with the export price levels of countries exporting similar commodities. The shift from absolute to relative prices is necessary for (a) logical and (b) statistical reasons.

(a) Exchange depreciation, in social club to improve the competitive position of a state, must lower the price level of the country itself not merely in absolute terms but likewise in comparing with the price levels of competing countries. The price fall in the depreciating country may entail a fall in prices in competing countries, so that the relative price fall will be smaller than the absolute price fall of the first country.

(b) Statistically it appears necessary to measure out the effectiveness of depreciation by reference to relative rather than accented prices, considering many factors in addition to fluctuations in the substitution rate influence absolute prices and thus obstruct ascertainment of the effects of changes in rates. Since, however, these other factors may exist assumed to affect competing countries roughly in the same way, the price ratio betwixt the two countries may be causeless to reverberate mainly fluctuations in the relative rate of exchange betwixt them. Among the other factors, mention should be fabricated in particular of fluctuations in globe market place prices of raw materials and fluctuations in world demand. Both have an influence on the absolute level of consign prices of any i state, which often overshadows the influence of moderate fluctuations in the charge per unit of commutation. By calculating the ratio of the export prices of one country to those of some other, however, the effect of these full general factors is largely eliminated.

Therefore, an try will be made here to measure out the effectiveness of depreciation by reference to relative export prices. The effectiveness is defined as the pct change in the ratio of the export prices of 2 countries (prices in both being expressed in the same currency) which is associated with a 1 per cent change in their exchange rate.⁶

The effectiveness, so defined, could be estimated for any pair of countries or for every individual state compared with some weighted average of all its competitors, with weights based on the extent to which its products were in competition with those of other countries. In the examples which follow, one country of comparison, rather than a weighted average of many countries, has been taken only for convenience; and in all the examples the one country is the United States.

A comparing betwixt two countries yields results which may reflect the reactions of either or maybe of both. This point is analyzed in the Appendix. The conclusions of this analysis are that the comparisons of the United Kingdom with the United States and of Sweden with the United States measure primarily the effectiveness of depreciation as far equally the U.s. is concerned; in the other cases considered, the effectiveness measured is that of the country which is existence compared with the United states (i.eastward., French republic and Poland).

It was found in the preceding section that the slope and the "mobility" of the supply curve are profoundly affected by the level of activity in the depreciating country; the slope of the strange need curve may, on the other hand, exist causeless to be relatively constant under varying weather condition. Appropriately, information technology would be expected that conditions of slump, boom, aggrandizement, and hyperinflation would, in the society listed, testify decreasing coefficients of effectiveness of depreciation. These expectations are confirmed by the examples described below and summarized in Table 1.

Tabular array one.

Effectiveness of Depreciation under 5arious Supply Conditions

Table 1.

Effectiveness of Depreciation under Fivearious Supply Conditions

Supply Conditions		Countries Compared			Menstruation		Coefficient of Effectiveness of Depreciation	Chart Reference
I.	Slump	U. One thousand. —U. Due south.			1931-33		0.04	2
		Sweden—U. S.			1931-33		0.99	3
		France—U. South.	A.	I	Q—I Five Q 1933		0.95	five
II.	Boom	France—U. S.	B.	Three	Q 1936—Ii Q	1937	0.35	5
		France—U. Due south.	C.	III	Q 1937—Four Q	1938	0.70	5
III.	Inflation	France—U. Southward.	A.	I	Q—I 5 Q 1919		0.95	vi
			B.	I	Q 1920—Four Q	1922	0.77	6
			C.	I	Q 1923—Iii Q	1924	0.44	six
			D.	IV	Q 1924—III Q	1926	0.33	6
		Poland—U. S.		3	Q 1921—II Q	1922	0.40	7
4.	Hyperinflation	Poland—U. Southward.		3	Q 1922—3 Q	1923	0	7
		Poland—U. S.		III	Q—IV Q 1923		Negative	seven

The coefficients indicate only the general order of magnitude of the effectiveness of exchange depreciation and should by no means be considered as precise measurements because, among other reasons, the number of observations on which they are based is quite small. In particular, the coefficients of effectiveness found for depreciation in slump weather condition would appear to be the maximum that might be expected on theoretical grounds.^vii In general, notwithstanding, the furnishings shown are in such satisfactory accord with the expectations derived from the theoretical model developed above that we may be reasonably confident of their approximate accuracy.

Depreciation in slump conditions

Nautical chart 2 compares quarterly figures of the ratio of British to American export toll indices for manufactured products (both in terms of the same currency) and the sterling-dollar exchange rate (both ratios given as index numbers, 1930 = 100). The gradient of the regression lines fitted to the points in the chart is 0.94. This would signal that during the catamenia considered a one per cent depreciation of the dollar vis-à-vis sterling would have lowered American prices by 0.94 per cent compared with British consign prices, and it might be assumed that the effectiveness equally far as a depreciation by the United Kingdom is concerned would have been of the same society of magnitude. In that period, ex-alter depreciation by either the United Kingdom or the Us would probably have been almost completely effective, because of an inelastic foreign demand combined with a very elastic home supply.

Nautical chart 2.

Ratio of British to U. S. Export Price Indices, Compared with Sterling-Dollar Commutation Charge per unit, 2d Quarter, 1931—Fourth Quarter, 1933

(Index numbers, 1930 = 100; double logarithmic scale)

Citation: Imf Staff Papers 1950, 001; 10.5089/9781451959994.024.A003

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Nautical chart 2.

Ratio of British to U. S. Consign Toll Indices, Compared with Sterling-Dollar Exchange Rate, 2d Quarter, 1931—4th Quarter, 1933

(Index numbers, 1930 = 100; double logarithmic scale)

Citation: IMF Staff Papers 1950, 001; 10.5089/9781451959994.024.A003

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Such statistical estimates equally are available on the price elasticity of strange demand for the exports of both the United states and the United Kingdom in the interwar period give very low figures: for both countries, approximately — 0.4.^viii While these estimates cannot be taken as having a high degree of precision it would seem plausible that the elasticities would exist depression. Thus, as far as the United kingdom of great britain and northern ireland is concerned:

(a) British exports consist to a large extent of specialized industrial products and the possibilities of substitution for such products are unremarkably limited.

(b) The Uk bulks big in world merchandise in industrial products and her share in private markets is particularly high. This "monopolistic" position also tends to make the elasticities of foreign need for her exports low.

On the supply side in the early thirties in that location was large-scale united nations-employment, ample unused capacity, and big stocks of commodities in both the U.s.a. and the Great britain. In these atmospheric condition the supply of commodities for consign must take been well-nigh completely elastic.

In these same weather in that location was besides extremely little tendency for the supply curve of the depreciating country to move upwards, either absolutely or in relation to that of the country of comparison. When Britain depreciated in 1931, the price of many of her raw materials did not increase, since the countries from which they were imported, such as the Dominions and the Scandinavian countries, depreciated their currencies at well-nigh the same fourth dimension and sometimes even to a greater extent. British wage rates continued to fall during the period 1931-33. Generally speaking, the money wage charge per unit in the United Kingdom was closely continued with fluctuations in the cost of living and in the level of employment. The cost of living index continued to refuse during this menstruation because of the autumn in import prices in terms of sterling. Although the index of employment showed some increment after the depreciation, the actual corporeality of unemployment remained very large and recovery did not become well nether fashion until the building boom started in 1934. Thus all factors worked in the management of making the depreciation almost completely effective.

The data on Sweden compared with the United states of america^nine show a very similar motion picture, the human relationship between percentage changes in relative prices and in the exchange charge per unit appearing as high equally 0.99 (Chart iii).

Chart 3.

Ratio of Swedish to U. S. Export Cost Indices, Compared with Krona-Dollar Commutation Rate, Second Quarter, 1931—Fourth Quarter, 1933

(Index numbers, 1930 = 100; double logarithmic scale)

Citation: IMF Staff Papers 1950, 001; 10.5089/9781451959994.024.A003

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Chart 3.

Ratio of Swedish to U. S. Export Price Indices, Compared with Krona-Dollar Substitution Charge per unit, Second Quarter, 1931—Fourth Quarter, 1933

(Index numbers, 1930 = 100; double logarithmic scale)

Citation: International monetary fund Staff Papers 1950, 001; x.5089/9781451959994.024.A003

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The elasticity of strange demand for Swedish exports with respect to price was probably small; it has been estimated every bit —0.37 for the interwar menses.¹⁰ This depression elasticity occurs in spite of the fact that Sweden'south share in world markets of manufactured products is small; it probably reflects the facts that Swedish exports consist partly of very specialized industrial products such equally telephone apparatus, ball bearings and roller bearings, etc., for which substitution of competing exports is very limited, and that Sweden's share in certain categories of goods, such as fe ore, pig fe, and iron castings, is quite large.

In Sweden, equally in the Great britain, low weather prevailed in the early thirties, with unemployment and falling wages, which would brand any upward shift of the supply bend improbable and tend to make for a very elastic supply bend.

Depreciation in nail conditions

The period 1933-38 for which the French experience has been analyzed may be divided into four segments, reflecting different cyclical positions in French republic: (a) kickoff quarter 1933—fourth quarter 1933, (b) beginning quarter 1934—kickoff quarter 1936, (c) second quarter 1936—second quarter 1937, (d) 3rd quarter 1937—quaternary quarter 1938. The effectiveness of changes in the French exchange rate in these four periods was quite different. A statistical estimate of the elasticity of foreign demand for French exports for the interwar period sets this elasticity at — 0.77;¹¹ no statistical evidence was found to indicate that this elasticity differed in different phases of the trade cycle.

In the absenteeism of quarterly figures for French export prices, quarterly figures of the French wholesale toll alphabetize take been used. As shown in Chart four, the changes in the annual figures of the wholesale price alphabetize and those of the export price index agree very closely.

First quarter 1933—fourth quarter 1933: Slump in France. During this catamenia the United States depreciated while France remained on gilt. This case may be treated as one of exchange appreciation by France. As shown in Chart v, the four quarters of 1933 prevarication very closely along a straight line on a logarithmic scale (line A) with a slope of nearly 0.95. This means that the French appreciation raised the relative price level of France by 95 per cent of the extent of the appreciation. The loftier value for the coefficient is deemed for, equally in earlier cases, past the inelastic foreign demand and the rubberband supply, both in France and in the Us.

Chart 5.

Ratio of French to U. S. Wholesale Price Indices, Compared with Franc-Dollar Exchange Charge per unit, First Quarter, 1933—4th Quarter, 1938

(Index numbers, 1930 = 100; double logarithmic scale)

Citation: Imf Staff Papers 1950, 001; 10.5089/9781451959994.024.A003

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Chart 5.

Ratio of French to U. S. Wholesale Price Indices, Compared with Franc-Dollar Exchange Rate, First Quarter, 1933—Fourth Quarter, 1938

(Index numbers, 1930 = 100; double logarithmic scale)

Citation: IMF Staff Papers 1950, 001; 10.5089/9781451959994.024.A003

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Kickoff quarter 1934—first quarter 1936. The relative parities remained unchanged during this period simply prices in French republic, compared with prices in the United States, fell steadily until the fourth quarter of 1935. At the beginning of 1934, the dollar was stabilized and from and then on U.s. export prices remained practically unchanged. The changes in relative prices were due to the fall of French consign prices and were not direct continued with the exchange rates. The rapid fall of French prices was the event of a most drastic deflation policy in France, acquired mainly by the deterioration of the French balance of payments and by the unwillingness to go off aureate. The deflation policy took the form of a sharp reduction in authorities expenditures and of direct cuts of salaries, wages, retail prices, involvement rates, etc.

Past the fourth quarter of 1935, the French farmer became unwilling to stand farther deflation and the Government took diverse steps to enhance farm prices by increasing agricultural subsidies, etc. The internet issue was a progressive ascension in the cost of living and in the prices of agricultural raw materials. Wage rates as well showed some tendency to ascent. Thus from the quaternary quarter of 1935 to the establishment of the Popular Front in June 1936, French prices recovered somewhat.

Third quarter 1936—4th quarter 1937: Smash weather in France. This was the menses of the so-called "Blum experiment." In order to promote rapid recovery of the national economy, 4 chief policies were adopted: (a) devaluation of the franc, (b) raising wage earnings by increasing wage rates and adopting holidays with pay, (c) "reflation," mainly by means of public works, and (d) the twoscore-hour week.

During this flow nail conditions prevailed in French republic. In the first quarter of 1937, the volume of production was non much higher up the lowest level of the slump; France was, nevertheless, rapidly budgeted a country of "full employment," as the xl-hour week law eliminated at i stroke fractional unemployment, and the supply of skilled labor suddenly became scarce. But whether total employment was genuine or artificial, its effect upon the French economy was the same. No further expansion of product was possible. The elasticity of supply of French exports was very low; hence depreciation became relatively ineffective. The up shift of the supply curve further tended to reduce the effectiveness of depreciation. It has been estimated by Kalecki that labor costs in French industry rose by 58 per cent during the Blum experiment,¹² as a event of increases of the coin wage rate and the adoption of holidays with pay. Moreover, depreciation led to an increase of the price of imported raw materials, estimated past Kalecki to have been 63 per cent.¹³

The slope of line B in Chart v, which is only 0.35, reflects the supply atmospheric condition, mentioned in the preceding paragraph. Owing to these weather, depreciation in this period led to a reduction of French prices in terms of gold compared with foreign prices by simply most one 3rd of the caste of depreciation.

3rd quarter 1937—fourth quarter 1938: Recession in France. The Blum Authorities went out of office in June 1937. Its successor, after a renewed depreciation of the franc, reversed the internal economic policy by adopting a policy of budgetary retrenchment. In the autumn of 1937, there was a recession in France. Industrial production declined continuously from Nov 1937 to August 1938. Wage rates and general price levels showed only very pocket-sized increases. Broadly speaking, the French economy during this menstruation was in a stage of mild recession, though not in a slump.

These atmospheric condition afflicted the coefficient of the effectiveness of exchange depreciation. Every bit shown by line C in Chart 5, the coefficient for this menses was 0.70.

Depreciation during inflation

In Chart half dozen quarterly changes in the ratio of French to Usa prices are shown in comparing with the dollar rate of exchange for the French franc from the first quarter of 1919 through the quaternary quarter of 1926. 3 interesting features may be observed.

Nautical chart six.

Ratio of French to U. Due south. Export Price Indices, Compared with Franc-Dollar Substitution Rate, First Quarter, 1919—Fourth Quarter, 1926

(Alphabetize numbers, 1919 = 100; double logarithmic scale)

Citation: Imf Staff Papers 1950, 001; 10.5089/9781451959994.024.A003

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Chart six.

Ratio of French to U. S. Export Price Indices, Compared with Franc-Dollar Exchange Rate, Outset Quarter, 1919—Quaternary Quarter, 1926

(Index numbers, 1919 = 100; double logarithmic scale)

Commendation: International monetary fund Staff Papers 1950, 001; ten.5089/9781451959994.024.A003

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Kickoff, the points lie closely forth four lines. In two cases the shift from ane line to the other reflects a sharp autumn of the commutation rate (A to B, and B to C), due to a very sudden and substantial fall of the exchange rate caused probably by speculative factors. In the terminal case (C to D) the shift represents a violent rise of relative prices, which may exist interpreted as a ascent of internal prices due to domestic inflationary factors to which there was no immediate aligning of the charge per unit of substitution.

Secondly, as the lines shift to the left their slopes gradually decrease. The slopes of the lines A, B, C, and D are, respectively, 0.95, 0.77, 0.44, and 0.33. This fall is due to the fact that, as inflation in France proceeded, the economy came nearer full employment and, in particular, all members of the economy became more aggrandizement-witting.¹⁴ Hence the elasticity of supply declined, and the supply curve adjusted itself more speedily and more fully to increased import prices in terms of francs. Thus successive rounds of depreciation became less constructive in lowering relative prices.

Thirdly, except for the shifts betwixt the various lines, to which nosotros have referred, there is no clear or consistent lag or pb betwixt the changes in relative prices (expressed in dollars) and changes in the substitution rate. This is probably due to a combination of factors. In the before flow, when the effectiveness of depreciation was still very large, the autumn of French prices in terms of dollars was instantaneous and the subsequent upward adjustment of the supply bend was minor. In the later stages, on the other mitt, when the significance of these upward adjustments became successively greater, the corrections themselves occurred quite quickly later the initial depreciation, as the population became increasingly inflation-witting.

Depreciation during hyperinflation

The best known example of hyperinflation is that of Germany in 1922-23. During the afterward stages of the German aggrandizement, the precipitous fall of the mark was accompanied by a gradual increase in the German toll level in terms of gold.¹⁵ The movements of prices in Deutschland in 1922-23 were so rapid, however, that statistical observation became particularly difficult. Consequently, diverse cost indices for Germany for that flow testify quite considerable differences, and quantitative conclusions based on such indices would be peculiarly liable to error. Nosotros prefer, therefore, to use Poland as an example; that country, though affected by hyperinflation, did not experience quite the light-headed speed of Germany.

Chart 7 ¹⁶ shows a coefficient of 0.40 for the relation between a fall in the exchange rate and the reject in relative prices from the tertiary quarter of 1921 to the period early in 1922. Such a coefficient is in accord with that establish for the later stages of the French inflation in 1923-26. Afterwards, notwithstanding, from the heart of 1922 until the tertiary quarter of 1923, while the exchange charge per unit fell from 36 per cent to 1 per cent of its par established in 1921, relative prices did not decline farther. At the stop of 1923 and soon before the stabilization, which occurred in April 1924, the miracle typical of hyper-inflation itself was shown. The substitution rate fell in one quarter by about ix tenths. At the same time, relative prices actually increased considerably with the result that in the fourth quarter of 1923 the zloty, according to the statistics used, was overvalued by about twoscore per cent.

Nautical chart 7.

Ratio of Smoothen to U. Southward. Wholesale Price Indices, Compared with Zloty-Dollar Exchange Rate, Third Quarter, 1921—First Quarter, 1924

(Double logarithmic scale)

Commendation: Imf Staff Papers 1950, 001; 10.5089/9781451959994.024.A003

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Chart vii.

Ratio of Polish to U. Southward. Wholesale Cost Indices, Compared with Zloty-Dollar Exchange Charge per unit, Third Quarter, 1921—First Quarter, 1924

(Double logarithmic scale)

Commendation: Imf Staff Papers 1950, 001; 10.5089/9781451959994.024.A003

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Thus, during the menstruum from 1921 to the end of 1923 Poland went through 3 stages of effectiveness of exchange depreciation: a stage of pocket-size but positive effectiveness at first; then a stage, which lasted almost two years, of approximately zero effectiveness; and finally a stage of negative effectiveness, coinciding with the presence of hyper-inflation.

APPENDIX

The purpose of this Appendix is to show more precisely the nature of the relationship investigated in the text. For this purpose it is convenient to present in algebraic class the various relations that have been assumed to exist. Exponential equations have been selected as the type probably most suitable to reflect these relations, in item when large price changes occur.

A number of variables and coefficients are introduced; those with subscript "westward" reverberate world weather condition, those without subscript or accent pertain to country 1, and those without subscript, but with an accent, to country 2:

p westward	world price level in terms of gold (of commodities imported by countries i and 2)
y w	world demand factor (affecting exports of countries 1 and 2)
p, p′	national price levels of export products in countries 1 and ii, respectively
x, x′	export volumes of countries 1 and 2
r, r′	rates of exchange of countries i and 2 in units of national currency per unit of measurement of gold
β, β′	total1 proportional increment of supply curve in response to rising in import prices expressed in national currency
γ, γ′	income elasticity of demand for exports of the 2 countries
η, η′	elasticity of substitution of demand for exports of the two countries (negative magnitudes)
ε, ε′	elasticity of supply of exports in the 2 countries

The following relations are assumed to hold. Abiding terms are omitted.

I. Price formation (supply equations)

$\begin{array}{cc}\left(1\right)& p=(p_w·r)\beta ·{\mathrm{10}}^{\frac{1}{\in }}\end{array}$

$\begin{array}{cc}\left(2\right)& p^{\prime }=(p_{\mathrm{west}}·r^{\prime }){\beta }^{\prime }·{{\mathrm{10}}^{\prime }}^{\frac{1}{{\in }^{\prime }}}\end{array}$

II. Determination of volume of exports (demand equations)

$\begin{array}{cc}\left(3\right)& \mathrm{ten}={(\frac{p}{p^{\prime }}·\frac{r^{\prime }}{r})}^{\eta }·y_{w^{\gamma }}\end{array}$

$\begin{array}{cc}\left(4\right)& x^{\prime }={(\frac{p^{\prime }}{p}·\frac{r}{r^{\prime }})}^{{\eta }^{\prime }}·y_{w^{{\gamma }^{\prime }}}\end{array}$

Combination of (1) and (3), and (2) and (4) yields

$\begin{array}{cc}\left(5\right)& p=(p_w·r)\beta ·{\left(\frac{p·r^{\prime }}{p^{\prime }·r}\right)}^{\frac{\eta }{\in }}\end{array}·{y_w}^{\frac{\gamma }{\in }}$

$\begin{array}{cc}\left(6\right)& p^{\prime }=(p_w·r^{\prime }){\beta }^{\prime }·{\left(\frac{p^{\prime }·r}{p·r^{\prime }}\right)}^{\frac{{\eta }^{\prime }}{{\in }^{\prime }}}\end{array}·{y_w}^{\frac{{\gamma }^{\prime }}{{\in }^{\prime }}}$

Hence for prices expressed in comparable units, the following are obtained:

$\begin{array}{cc}\left({\mathrm{five}}^{\prime }\right)& \frac{p}{r}={p_{\mathrm{westward}}}^{\beta ·r^{\beta -\mathrm{one}·}}{(\frac{p}{p^{\prime }}·\frac{r^{\prime }}{r})}^{\frac{\eta }{\in }}·{y_{\mathrm{west}}}^{\frac{\gamma }{\in }}\end{array}$

$\begin{array}{cc}\left(6^{\prime }\right)& \frac{p^{\prime }}{r^{\prime }}={p_w}^{{\beta }^{\prime }·{r^{\prime }}^{{\beta }^{\prime }-1·}}{(\frac{p^{\prime }}{p}·\frac{r}{r^{\prime }})}^{\frac{{\eta }^{\prime }}{{\in }^{\prime }}}·{y_w}^{\frac{{\gamma }^{\prime }}{{\in }^{\prime }}}\end{array}$

Division of (5′) by (vi′) gives

$\begin{array}{cc}\left(7\right)& \frac{p}{p^{\prime }}·\frac{r^{\prime }}{r}={p_w}^{(\beta -{\beta }^{\prime })}·{y_w}^{(\frac{\gamma }{\in }-\frac{{\gamma }^{\prime }}{{\in }^{\prime }})}·r(\beta -1)·r^{\prime }(\mathrm{ane}-{\beta }^{\prime })·{(\frac{p}{p^{\prime }}·\frac{r^{\prime }}{r})}^{[\frac{\eta }{\in }+\frac{{\eta }^{\prime }}{{\in }^{\prime }}]}\end{array}$

Writing ζ (a positive magnitude) for $-[\frac{\eta }{\in }+\frac{{\eta }^{\prime }}{{\in }^{\prime }}]$ yields

$\begin{array}{cc}\left(\mathrm{viii}\right)& \frac{p}{p^{\prime }}·\frac{r^{\prime }}{r}={p_{\mathrm{westward}}}^{\frac{\beta -{\beta }^{\prime }}{\mathrm{one}+\zeta }}·{y_{\mathrm{west}}}^{\frac{\frac{\gamma }{\in }-\frac{{\gamma }^{\prime }}{{\in }^{\prime }}}{1+\zeta }}·r^{\frac{\beta -1}{1+\zeta }}·{r^{\prime }}^{\frac{1-{\beta }^{\prime }}{1+\zeta }}\end{array}$

This form is not yet satisfactory for our purposes since it defines the toll ratio $\frac{p}{p^{\prime }}·\frac{r^{\prime }}{r}$ as a part of iv variables: p _w , r, r′, and y _w . Certain simplifying assumptions volition be necessary to limited the price ratio as a function of $\frac{r}{r^{\prime }}$ , i. e., the rate of exchange betwixt the two countries. Various simplifications, depending on the nature of the example analyzed, may be legitimate.

(a) The two countries may be such that it is reasonable to assume that γ is approximately equal to γ′ and ∈ to ∈′. This would reduce the influence of y _w , if information technology itself does non fluctuate too strongly, to an element of minor importance.

(b) It may further be permissible to assume that β is very near to β′. In this example the term with p _{due west} becomes insignificant. Assuming both (a) and (b), equation (eight) reduces to

$\begin{array}{cc}\left(9\right)& \frac{p}{p^{\prime }}·\begin{array}{c}{r}^{\prime }\\ r\end{array}={\left(\frac{r}{r^{\prime }}\right)}^{\frac{\beta -1}{1+\zeta }}\end{array}$

where $\frac{\mathrm{ane}-\beta }{1+\zeta }$ or $\frac{1-{\beta }^{\prime }}{1+\zeta }$ would stand for the effectiveness of depreciation for either land.ⁱⁱ

If, for example,

$\begin{array}{ccc}\hfill \beta ={\beta }^{\prime }=& \hfill \mathrm{0.ane}& \\ \begin{array}{c}\hfill \begin{array}{c}\eta ={\eta }^{\prime }=\end{array}\\ \in ={\in }^{\prime }=\hfill \end{array}\hfill & \hfill \begin{array}{c}\begin{array}{c}-0.5\end{array}\\ 4\end{array}\hfill & \}\text{and}\text{hence}\zeta =0.25;\mathrm{ane}+\zeta =1.25\end{array}$

so the figure found for the effectiveness would exist

$\frac{1-0.1}{1.25}=0.72$

A tabular array of the values for the effectiveness for various values of β, η, and ∈ is given beneath. The values for the three coefficients are all assumed equal for the two countries.

Values for $\frac{1-\beta }{1+\zeta }$ and $\frac{1-{\beta }^{\prime }}{\mathrm{i}+{\zeta }^{\prime }}$

The assumption is now made that condition (a) is rigorously fulfilled, but condition (b) is not. Then (8) may exist written equally follows:

$\begin{array}{cc}\left(\mathrm{ten}\right)& \frac{p}{p^{\prime }}·\frac{r^{\prime }}{r}=p_{\mathrm{west}}\frac{\beta -{\beta }^{\prime }}{1+\zeta }·r\frac{\beta -1}{1+\zeta }·r^{\prime }\frac{1-{\beta }^{\prime }}{1+\zeta }\end{array}$

This may be arranged in two ways:

$\begin{array}{cc}\left(10\text{a}\right)& \frac{p}{p^{\prime }}·\frac{r^{\prime }}{r}=(p_w·r)\frac{\beta -{\beta }^{\prime }}{\mathrm{ane}+\zeta }·\left(\frac{r}{r^{\prime }}\right)\end{array}\frac{{\beta }^{\prime }-1}{\mathrm{ane}+\zeta }$

$\begin{array}{cc}\left(10\text{b}\right)& \frac{p}{p^{\prime }}·\frac{r^{\prime }}{r}=(p_w·r^{\prime })\frac{\beta -{\beta }^{\prime }}{\mathrm{i}+\zeta }·\left(\frac{r}{r^{\prime }}\right)\end{array}\frac{\beta -\mathrm{ane}}{1+\zeta }$

The term (p _w · r) stands, information technology volition be recalled, for the price of imported materials expressed in local currency in land one. Hence, if this price level is constant, correlation of the price ratio $(\frac{p}{p^{\prime }}·\frac{r^{\prime }}{r})$ with $\frac{r}{r^{\prime }}$ volition yield an guess of the effectiveness for state 2 (equation 10a); and if p _{due west} · r′ is abiding, correlation will yield an approximate of the effectiveness for state one (equation 10b).

More generally, p _w · r may exist assumed to fluctuate to some extent with $\frac{r}{r^{\prime }}$ . Permit

$\begin{array}{cc}\left(11\right)& p_{\mathrm{due\; west}}·r={\left(\frac{r}{r^{\prime }}\right)}^{\rho }\end{array}$

Then it volition readily exist seen that the exponent plant by correlating $(\frac{p}{p^{\prime }}·\frac{r^{\prime }}{r})$ with $\frac{r}{r^{\prime }}$ will equal $\frac{{\beta }^{\prime }-1}{1+\zeta }+\rho \frac{\beta -{\beta }^{\prime }}{1+\zeta }$ . For ρ = 0 and ρ = 1 this yields the answers indicated in the preceding paragraph. In general, the exponent plant will be between the values for the effectiveness of the two countries provided 0<ρ<one, i.e., that absolute import prices in the depreciating state increase, but by less than the extent of depreciation.

In the statistical observations bearing on depreciation in the slump, weather condition (a) and (b) would seem to be approximately satisfied. Since import prices remained more virtually abiding in the countries which depreciated in 1931-32 than in the United States, the measured effectiveness of depreciation for those years probably refers more near to that of the United States than to that of the countries compared with the United States. But in 1933, French import prices, relative to those for the United States, declined, while the number of francs per dollar as well declined; the coefficient of effectiveness, therefore, should be read primarily every bit applying to France.

(c) In other situations, where r and p fluctuate sharply over a short period of time, the fluctuations in p _west , y _w , and r′ during the same menses may be insufficiently negligible. The terms with p _{due west} and y _w may then be left out of business relationship even though their coefficients are not causeless to be negligible. In that case, (9) would also concur; only the coefficient plant should be interpreted either as a measurement of $\frac{\beta -\mathrm{i}}{1+\zeta }$ , if p and r fluctuate during the period of ascertainment, or of $\frac{{\beta }^{\prime }-\mathrm{i}}{1+\zeta }$ , if p′ and r′ fluctuate.

In the observations on depreciation or nail and aggrandizement, weather (a) and (b) are probably not applicable, simply (c) is; in these circumstances information technology is the effectiveness of depreciation for the depreciating country which is measured.

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Source: https://www.elibrary.imf.org/view/journals/024/1950/001/article-A003-en.xml

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