Mr. Fleming, Advisor in the Department of Research and Statistics, is a graduate of Edinburgh University. He was formerly a member of the League of Nations Secretariat, Deputy-Director of the Economic Section of the U.K. Cabinet Offices, U.K. representative on the Economic and Employment Commission of the United Nations, and Visiting Professor of Economics at Columbia University. He is the author of numerous articles in economic journals.
It is assumed that the private marginal propensity to spend will always be less than unity with respect to income before tax.
It is assumed that the marginal propensity for the balance of trade to decline as expenditure increases is less than unity.
Since the marginal propensity to spend out of income is less than unity and since a fraction of each round of expenditure leaks abroad in additional net imports, the increase in income and expenditure will be limited, though possibly large. See Appendix, paragraphs 3 and 4.
The rise in tax revenue could exceed the initial rise in government expenditure only if the marginal propensity to spend out of private income after tax were substantially greater than unity. See Appendix, paragraph 5.
The only clear-cut alternative would appear to be that of defining constancy of monetary policy as the maintenance of a constant rate of interest. In “Flexible Exchange Rates and Employment Policy,” Canadian Journal of Economics and Political Science (November 1961), Mr. R. A. Mundell has compared the effects of monetary policy (defined as interest policy), fiscal policy, and commercial policy in a flexible exchange rate system and a fixed exchange rate system, respectively.
It is uncertain whether private expenditure, stimulated by the rise in income and depressed by the rise in interest, will increase or decrease. But expenditure as a whole, like income, will increase, except where income velocity is entirely inelastic. See Appendix, paragraphs 6 and 7. In this extreme case, not only expenditure but also income and the balance of trade will remain unchanged.
It is assumed not only that the exchange rate will remain fixed but that there will be no resort to restrictions on international transactions.
See Appendix, paragraph 11.
A high sensitivity of the interest rate to changes in velocity of circulation, i.e., a low elasticity of velocity with respect to the interest rate, while it makes for a favorable balance of payments response to government spending, and while it therefore tends to make the income response smaller under floating than under fixed exchange rates, also tends to reduce the magnitude of that response under both exchange systems. If the velocity of circulation were completely inelastic, a change in government expenditure would have no net effect on income under either exchange system.
See Appendix, paragraphs 15 and 16. However, in the extreme case where velocity of circulation is completely inelastic, money income will rise proportionately to the money stock under either exchange system. See Appendix, paragraph 17.
To put the same thing in other words, the effect under a floating rate relative to the effect under a fixed rate will never be greater, and will generally be less, in the case of budgetary expansion than in the case of monetary expansion.
We have to neglect, as unknown, any effects on trade of the difference in the composition of expenditure under the two policies.
It should be noted, however, that the responsiveness of capital movements to interest rate changes is made up of two components: a relocation of existing capital and a shift in the location of the placement of new savings. Since the former component is nonrecurrent and the latter recurrent in character, it is probable that the sensitivity of capital movements to interest changes will be greater in the short run than in the long run. Consequently, the difference between the two policies with respect to effectiveness and sustainability is also likely to be less in the long run than in the short.
Exchange speculation has a bearing not only on the relative effectiveness, but also on the practicability and sustainability, of the two policies. Under exchange rates that are fixed and are expected to remain so, exchange speculation would be absent. But if confidence in the fixed rate were less than complete, the fear of arousing disequilibrating movements of capital would tend to limit the magnitude and duration of the expansionary financial policies, particularly of monetary policy, the effect of which on the balance of payments is in any case the more adverse than that of budgetary policy.