This paper presents a simple model of adjustment to devaluation in the context of a small, open economy consisting of traded goods, non-traded goods, and money. The analysis stresses the purely transitional importance of substitution and liquidity effects following devaluation, and at the same time, derives the time path of adjustment of the trade balance and the price of non-traded goods. The major result of interest is that during the process of adjustment, the substitution and liquidity effects both act so as to improve the trade balance, but work in opposite directions on the excess demand for non-traded goods.
ASJC Scopus subject areas
- Economics and Econometrics