The Contributions of Leland B. Yeager to International Economics

Article excerpt

Throughout his career, Leland B. Yeager has extended his contributions to domestic monetary theory to the realm of international economics. While he has written in the area of pure trade theory (Yeager and Tuerck, 1976, for example), his most significant contribution is probably his International Monetary delations (1966,1976), a landmark book that soon became the standard reference in the field of international money and finance. This paper focuses on the many contributions of that seminal work.

At the time of publication, Yeager's book was unique in several ways. First, it was highly unusual for a book in international economics to focus solely on the monetary aspects of the subject. By the time of the second edition, a monetary approach to international economics had again become fashionable. Second, his book is evenly divided between theory and historical narrative. (Friedman and Schwartz's 1963 narrative had been published only three years earlier.) In the latter half of his text, Yeager provides a history of the international monetary system in the twentieth century. His purpose is to focus on the policy lessons that can be learned from the historical experiences in the light of economic theory. Third, his book was probably the most balanced and thorough presentation of the case for freely floating exchange rates.

The first half of the book focuses on the automatic adjustment mechanisms that operate under a system of either fixed or freely floating exchange rates. These two systems provide a contrast to the system then in existence: the Bretton Woods system of fixed-but-adjustable exchange rates. Unlike the other two systems, this one lacked any automatic adjustment mechanism. The consequences of this deficiency are developed throughout the book.

The ajustaient mechanisms under fixed and floating rates

Under a fixed rate system, a country experiencing a balance-of-payments deficit must undergo deflation. If prices are not sufficiently flexible for full adjustment, then real income must also fall. This much is standard fare. However, Yeager focuses on two other mechansims that are often overlooked: the cash-balance effect and relative price adjustments.

One of the themes of Yeager's domestic monetary theory is the cash-balance effect, which he applies to the international sector. He argues (1966, p. 64):

In the...deficit country, the cash balances of individuals and business firms shrink....Out of concern not to let their cash balances shrink too far, people in the deficit country become less eager than before to buy capital assets and consumption goods alike. Decisions about buying and selling and managing cash balances interlock. It is strange that this adjustment effect should have been so widely overlooked even in the traditional analysis relying on the quantity theory of money; for anything better than a purely mechanical version of the quantity theory must emphasize how the money supply interacts with demands for cash balances so as to affect people's market behavior and thereby-rather than is some direct magical way-affect prices....

Yeager also emphasizes the role of shifts in the relative prices of traded and non-traded goods. The prices of the former are determined on world markets and therefore tend to move by smaller percentages than the prices of a country's non-traded goods. Hence, a deficit country will experience a relative decline in the prices of its domestic goods and services, which include factors of production. He argues (1966, p. 65):

Because domestic goods become relatively cheaper, ...[the residents] shift their buying away from imports and exportable goods onto domestic goods and...concentrate their production and sales efforts on the more favorable foreign market....These substitution effects are important and deserve attention far out of proportion to the space needed to state them.

Yet the popular strong version of the monetary approach to the balance of payments assigns a minor role to relative price changes. …