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The Monetary Approach to the Balance of Payments (Collected Works of Harry Johnson) by Harry G. Johnson, Jacob A. Frenkel

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7

Devaluation, Money, and Non-Traded Goods1

RUDIGER DORNBUSCH

This chapter develops a monetary approach to the theory of currency devaluation.2 The approach is ‘monetary’ in several respects. The role of the real balance effect is emphasised and a distinction is drawn between the relative prices of goods, the exchange rate and the price of money in terms of goods. Furthermore, money is treated as a capital asset so that the expenditure effects induced by a monetary change are spread out over time and depend on the preferred rate of adjustment of real balances.3 The latter aspect gives rise to the analytical distinction between impact and long-run effects of a devaluation.

The first part of this chapter develops a one-commodity and two-country ...

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