Mr. Polak, Deputy Director of the Department of Research and Statistics, is a graduate of the University of Amsterdam. He was formerly a member of the League of Nations Secretariat, Economist at the Netherlands Embassy in Washington, and Economic Adviser at UNRRA. He is the author of An International Economic System and of several other books and numerous articles in economic journals.
Central Planning Bureau, Central Economic Plan for 1955 (The Hague, 1955).
J. M. Keynes, The General Theory of Employment, Interest and Money (London and New York, 1936).
Even in Keynes’ own early application of the multiplier to policy problems, the marginal propensity to consume is handled almost purely on an illustrative basis, as is evident from the following quotation from his The Means to Prosperity (New York, 1933), p. 10: “What proportion of this additional income will be disbursed as additional expenditure? Insofar as it accrues to the wage-earning classes, one can safely assume that most of it will be spent; insofar as it increases profits and salaries and professional earnings, the proportion saved will be larger. We have to strike a rough average. In present circumstances, for example, we might assume that at least 70 per cent of the increased income will be spent and not more than 30 per cent saved.”
R. F. Kahn, “The Relation of Home Investment to Unemployment,” Economic Journal (London), Vol. 41 (1931), pp. 173–98.
Professor Meade was, I believe, the first to make investment endogenous by linking expected profits to current profits and thus being able to introduce an “incentive to invest” with respect to income. See J. E. Meade, “A Simplified Model of Mr. Keynes’ System,” Review of Economic Studies (London), Vol. 4, No. 2, February 1937, pp. 98–107.
Professor Baumol has put forward an alternative theoretical suggestion, viz., that cash balances should vary in proportion to the square root of the value of transactions. This alternative does not, however, seem to have general validity. See J. J. Polak and William H. White, “The Effect of Income Expansion on the Quantity of Money.” Staff Papers, Vol. IV (1954–55), p. 416, footnote 15.
A valuable business cycle theory has been built on the comparable assumption that holdings of another category of circulating capital, inventories, would be proportional to sales.
In “Keynesian Economics and the Quantity Theory,” Don Patinkin shows that, under plausible assumptions, from “the analytical framework … of the modern income-expenditure approach … emerges … [the voice] of the traditional quantity theory.” (Kenneth K. Kurihara, ed., Post Keynesian Economics, New Brunswick, N.J., 1954, p. 139.)
The effects of import restrictions correspond to those of equivalent increases in exports.
See Earl Hicks, Graeme S. Dorrance, and Gerard R. Aubanel, “Monetary Analyses,” in “Recent Developments in Monetary Analysis,” Staff Papers, Vol. V (1956–57), pp. 342 ff.
Domestic nonmonetary liabilities are either netted out against domestic assets or, in the annual Economic Survey of the Economic Commission for Latin America, treated separately in a residual category called “money supply absorbed.”
A similar point of view on the subject of a proper choice of models has been expressed by Dr. Holtrop: “It is clear that such a model [i.e., a multiplier model] cannot fit the purposes of a central bank. If one analyzes monetary phenomena with the purpose of getting some guidance for monetary policy, one must necessarily use a model in which monetary policy can find its place. If we believe that by monetary policy we can exert an influence on the creation of money, and maybe also on the propensity of the business community to hoard or to dishoard, and if we further believe that the exertion of such influence will affect the course of the inflationary or deflationary process, then, for the exposition of our ideas, we must choose a model in which the creation and cancellation of money and the acts of hoarding and dishoarding are treated as autonomous factors.” See M. W. Holtrop, “Method of Monetary Analysis Used by De Nederlandsche Bank,” in “Recent Developments in Monetary Analysis,” Staff Papers, Vol. V (1956–57), pp. 305–6.
J. J. Polak, “The Foreign Trade Multiplier,” American Economic Review (Menasha, Wisc.), Vol. 37 (1947), pp. 889–97; Gottfried Haberler, “Comment,” ibid., pp. 898–906; J. J. Polak and G. Haberler, “A Restatement,” ibid., pp. 906–7.
Assume that both exports and imports have an autonomous component (Xa and Ma) and an induced component Xi and Mi, the latter being linearly dependent on income:
Assume that the true structural import equation is in real terms, linking the volume of imports (m) to the volume of real income (y), while it also contains a substitution term:
Note that the special notations used in footnote 16 do not apply in the rest of the paper.
This coefficient is not used until later.
The validity of this assumption is discussed in Polak and White, op. cit., p. 411.
This is a necessary assumption; see below.
Assuming marginal propensity to import equals average propensity to import.
See, for example, Fritz Machlup, International Trade and the National Income Multiplier (Philadelphia, 1943).
Based on 1952 figures taken from “The Dollar Value of the World’s Money Supply,” International Financial Statistics (Washington), July 1953, pp. vi-viii.
A nonnumerical discussion of the process that follows an expansion of exports is given by E. M. Bernstein in “El Precio del Café y la Politica Monetaria” (“The Price of Coffee and Monetary Policy”), El Trimestre Económico (Mexico, D.F.), Vol. 17 (1950), pp. 416–38. The conclusions reached there are the same as those of this paper.
E. M. Bernstein, “Strategic Factors in Balance of Payments Adjustment,” Staff Papers, Vol. V (1956–57), pp. 153–54.
The additional condition of a fixed rate of exchange is necessary in the sense that any regime under which the balance of payments adjusts itself automatically through changes in the rate excludes the possibility of a balance of payments deficit by assumption.
A recent example is found in De Nederlandsche Bank, Report for the Year 1954 (Amsterdam, 1955), p. 65: “If as the result of inflationary impulses economic activity increases, or prices and incomes rise, or if in a word such impulses enlarge the national income, then the cash requirements of the households taking part in transactions will inevitably also become greater. This greater need for cash will be met through a part of the income received not being spent.… In the conditions existing in the Netherlands, the extent to which money becomes ‘fixed’ in cash holdings is of the order of 30 per cent of the increase in the annual national income. From another point of view this means that an inflationary impulse, provided that it does not lead to a balance of payments deficit—in which case newly created or activated money would disappear from circulation and cease to produce any stimulating effect on the domestic economy—and provided that the impulse is not offset by a deflationary impulse elsewhere, will continue to produce its inflationary effect until such time as increased activity or price rises have produced an ‘income effect’ amounting to roughly three times as much as the impulse. The point is that each addition to income tends when it is spent to cause fresh additional income to arise ; and only the fact that a part of each fresh addition to income is left unspent so as to meet the greater need for cash due to the rise in income prevents the inflationary impulses from producing a constantly extending cumulative effect. In any inflationary process therefore we should always find an increase in cash holdings, expressed in the form of an accumulation of primary liquid resources.”
Although one of the two reservations made envisages the possibility of an induced balance of payments deficit, this complication is not pursued, and a quan-titative conclusion for the Netherlands is reached on the basis of the quantity theory. In a journal article, however, Dr. Holtrop indicates explicitly that the “monetary multiplier” (i.e., the inverse of the velocity of money) applies only in a closed economy. In an open economy one also has to take account of the import leak, “as a result of which the remaining income effect would become smaller and smaller, ultimately vanishing when the cumulative balance of payments effect will have equaled the value of the initial inflationary impulse.” (M. W. Holtrop, “The Interpretation of Monetary Phenomena” [in Dutch], Economisch-Statistische Berichten (Rotterdam), Vol. 39 (1954), p. 994
S. C. Tsiang, “Liquidity Preference and Loanable Fund Theories, Multiplier and Velocity Analyses: A Synthesis,” American Economic Review (Menasha, Wise.), Vol. 46 (1956), p. 563. After reaching this conclusion, the author recommends velocity analysis for the study of development problems in underdeveloped countries—which surely are not typically closed economies—while sounding a warning against the use in such cases of the multiplier method whose conclusions are considered to be “dangerously misleading.”
The validity in this form is equivalent to that meaningless way in which the multiplier can always be shown to be exactly equal to the ratio of income to investment.
In this paragraph, M stands for money, which elsewhere in this paper is indicated as MO.
An important exception is a period of currency stabilization when the velocity of circulation is suddenly reduced and the economy can absorb a large quantity of money without inflationary effects.
If R represents reserves, desired reserves are R = kmY. Since
Eugene A. Birnbaum, “The Cost of a Foreign Exchange Standard or of the Use of a Foreign Currency as the Circulating Medium,” Staff Papers, Vol. V (1956–57), pp. 477–91, in particular, Group III in his Table 2. The same paper also shows that, for countries in this position, the ratio of foreign exchange to currency alone exceeded 100 per cent so that there was, in the long run and in retrospect, no economy for them in using a currency of their own.
M. W. Holtrop, “Method of Monetary Analysis Used by De Nederlandsche Bank,” Staff Papers, Vol. V (1956–57), p. 307.
In Germany, for instance, the velocity declined sharply in the pre-1914 period. See Ernest M. Doblin, “The Ratio of Income to Money Supply: An International Survey,” Review of Economics and Statistics (Cambridge, Mass.), Vol. 33 (1951–52), pp. 201–13, and International Financial Statistics (Washington), November 1951.
Clear evidence of the relationship for South Africa has been brought forward in a recent article by Dr. G. de Kock, “Die Verhouding van die Volksinkome tot die Geldvoorraad in Suid-Afrika, 1917–54,” South African Journal of Economics (Johannesburg), Vol. 23 (1955), chart on page 201. See also “Money Supply and National Income: The Income Velocity of Money and the Rate of Interest,” International Financial Statistics (Washington), November 1951, pp. iii-v.
Ernest M. Doblin, op. cit.
Tse Chun Chang, “International Comparison of Demand for Imports,” Review of Economic Studies (London), Vol. 13 (1945–46), No. 34, pp. 53–67.
Doblin also shows that the ratio of money to income in the same country increases over time, presumably because income rises. However, the ratio of imports to income has more generally been held to decline over time, although the evidence on this is by no means clear: cf. United Nations, World Economic Survey, 1955 (New York, 1956), pp. 51–53.
Neither Chang nor Doblin has been able to give a statistically satisfactory explanation that would fit the data for all countries. Doblin limited his explanation to 13 countries, after eliminating both the Scandinavian and the Anglo-Saxon countries for special reasons. His main correlation was, moreover, based on the ratio of currency to income; with the ratio of currency plus demand deposits to income, the regularity was said to be less good Chang stratified his countries in three groups, within which the propensity to import is related to real income. The differences between the groups are attributed to different degrees of specialization, but the evidence on this seems inconclusive.
The result of a somewhat more refined correlation calculation made with the data should be reported here. For 43 countries (all those in Table 3 except Costa Rica, El Salvador, Indonesia, Iran, and Iraq), an attempt was made to explain the average propensity to import (m) on the basis of per capita income (y) and population (p), using logarithms of the three variables. The result was:
Based on data from Statistical Office of the United Nations, Per Capita National Product of Fifty-Five Countries, 1952–1954 (New York, 1957).
The weighted average lag is found to be as follows: