A Many-Country Model of Equilibrating Adjustments in Prices and Spending
Paul S. Armington *,
The trade model outlined below is part of a study on the methodology of forecasting the effects of changes in exchange rates. This fact helps to explain the present form of the model. Certain features of the model, mainly the use made of data on the structure of trade, may prove to have more general application in a model designed to study the international interaction between prices, trade, incomes, and expenditures.
Mr. Rhomberg, Assistant Director in the Research Department, is a graduate of the University of Vienna and of Yale University and has been a member of the faculty of the University of Connecticut and of Yale University. He has contributed chapters to several books on economic subjects and articles to economic journals.
A paper presented at the first annual working session of Project LINK, held September 16–20, 1969, in Hakone, Japan. Project LINK is an international research project with the purpose of constructing a world trade model through linking together existing econometric models and giving suitable representation to the economies of countries and regions for which models do not yet exist. At present, public and academic research organizations from eight countries and two international organizations are participating in the project, which is directed by Professor Lawrence R. Klein of the University of Pennsylvania.
For a survey of existing trade models, see Grant B. Taplin, “Models of World Trade,” Staff Papers, Vol. XIV (1967), pp. 433–55, especially the bibliography on pp. 452–53.
See also the approach to this problem chosen by F. G. Adams, H. Eguchi, and F. Meyer-zu-Schlochtern in Chapter VI of An Econometric Analysis of International Trade (OECD, January 1969), pp. 43–59.
Rudolf R. Rhomberg and Lorette Boissonneault, “Effects of Income and Price Changes on the US. Balance of Payments,” Staff Papers, Vol. XI (1964), pp. 59–124.
Herbert B. Woolley, Measuring Transactions Between World Areas, (Columbia University Press, 1966).
See Rudolf R. Rhomberg, “Transmission of Business Fluctuations from Developed to Developing Countries,” Staff Papers, Vol. XV (1968), pp. 1–29.
See, e.g., Helen B. Junz and Rudolf R. Rhomberg, “Prices and Export Performance of Industrial Countries, 1953–63,” Staff Papers, Vol. XII (1965), pp. 224–71, and Mordechai E. Kreinin, “Price Elasticities in International Trade,” The Review of Economics and Statistics, Vol. XLIX (1967), pp. 510–16.
J. C. Siebrand, “The Short-Term Impact of Pressure of Demand Fluctuations on International Trade” (a paper submitted to the meeting of the European Group of Project LINK in Paris on May 22, 1969).
For instance, in the Fund’s three-region world trade model, travel is related to consumption or gross national product (GNP), transportation to trade, investment income to the stock of foreign investments and rates of earnings, and other services to GNP.
Mr. Armington, economist in the Current Studies Division of the Research Department, is a graduate of Swarthmore College and the University of California at Berkeley. Before joining the Fund in 1965, he was a Research Fellow in Economics at the Brookings Institution.
See Paul S. Armington, “A Theory of Demand for Products Distinguished by Place of Production,” Staff Papers, Vol. XVI (1969), pp. 159–78.
Extension of the model to cover any number of goods is under study.
The trade variables and the elasticities are expressed in value terms.
See Paul S. Armington, “The Geographic Pattern of Trade and the Effects of Price Changes,” Staff Papers, Vol. XVI (1969), pp. 179–201. Data similar to the elasticity coefficients used in the model are shown in Table 4 (p. 189) of that paper. Note that if the good identified in the model refers to merchandise-in-general, the parameter η‘, discussed in that article, is probably about unity. On the other hand, if the good refers to some subclass of merchandise, the model’s price coefficients may depend importantly on estimates of the price elasticities of demand for this subclass, as well as on the elasticities of substitution.
This assumption derives from the assumed linear homogeneity of the underlying behavior functions. See Armington, “A Theory of Demand for Products Distinguished by Place of Production” (cited in footnote 10), pp. 161 and 165–66.
Of course, the initial excess demand might be zero, in which case the corresponding market-equilibrium equation would ensure that this balance would not be disturbed by price-expenditure changes necessitated by initial imbalances elsewhere.
The word “initial” here and below refers to the situation of imbalance. The initial demands, supplies, and expenditures may not refer to observed values, therefore, but rather to ex ante values computed on ceteris paribus assumptions.
These direct elasticities, of course, are measured in value terms: that is, they are equal to the corresponding volume elasticities plus unity.
In the analysis of exchange rate changes, the exogenous price variable serves to incorporate factors such as monopolistic cost-price adjustments which are occasioned by the exchange rate changes but not related directly to the output-capacity-unemployment situation.