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Adjustment in the World Economy

60 Pages Posted: 27 Apr 2000 Last revised: 18 Aug 2010

Paul R. Krugman

Princeton University - Woodrow Wilson School of Public and International Affairs; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Date Written: October 1987

Abstract

There is a widespread view that world payments imbalances can be remedied through increased demand in surplus countries and reduced demand in deficit countries, without any need for real exchange rate changes. In fact shifts in demand and real exchange rate adjustment are necessary couplets, not substitutes. The essential reason for this complementarity is that a much higher fraction of a marginal dollar of US than of foreign spending falls on US output. As a result, a redistribution of world spending away from the US leads to an excess supply of US goods unless accompanied by a decline in their relative price. Although some economists believe that the integration of world capital markets somehow eliminates this problem, this is a fallacy that confuses accounting identities with behavior. The paper also addresses a number of relates issues, such as the role of budget deficits in determining domestic demand and the effectiveness of nominal exchange rates changes in producing real depreciation.

Suggested Citation

Krugman, Paul R., Adjustment in the World Economy (October 1987). NBER Working Paper No. w2424. Available at SSRN: https://ssrn.com/abstract=227111

Paul R. Krugman (Contact Author)

Centre for Economic Policy Research (CEPR)

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National Bureau of Economic Research (NBER)

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Princeton University - Woodrow Wilson School of Public and International Affairs ( email )

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