Exchange-switching Policies and Monetary Order
What is Expenditure-switching policies?
By contrast, it relies primarily on price changes, and aim to adjust to a disequilibrium by altering not the level of aggregate demand, but rather the allocation of total spending between tradable and nontradable goods, services, and assets.
The objective is to alter the ratio of prices between tradables and nontradables.
In case of deficit, for instance, the idea is to raise the relative price of tradables in order to induce a switch of expenditures by residents toward nontradables (thereby reducing imports and/or releasing tradable goods production for export).
One way to do this is by facilitating, actively or passively, a formal movement of the exchange rate, in order to reinforce the automatic market response when rates are flexible.
The authorities may change the rate themselves, by devaluing (revaluing( the home currency in case of deficit (surplus).
Or, they may simply allow the currency to depreciate (appreciate) on its own, in accord with market forces.
Another way to do this is by introducing or removing restrictions (tariffs, quotas, etc.) or subsidies on current-account or capital transactions, in order to promote a preferred alternative to the automatic market response.
And a third way to do it is by suspending the free market in foreign exchange and resorting instead to exchange control.
With convertibility of the home currency into foreign currencies suspended, the authorities can ration foreign exchange to domestic residents under terms of their own choosing.
In the short term, exchange control leaves incomes, prices, and the exchange rate unaffected. But over the long term, rationing of foreign exchange inevitably causes expenditure switches, leading o shifts of resources and exchanges at the margin.
Policies using restrictions, subsidies, and exchange control all induce payments adjustment through selective price changes: they are like an informal, partial movement of the exchange rate.
A policy of formally moving the exchange rate differs in principle from these other expenditure-switching devices only in that the consequent change of relative prices is generalized to all goods, services, and assets.
What determines a government's choice from among this wide array of policy options? When will a government choose to finance an external imbalance, and when it will adjust to it? When it will choose to expenditure-switching policies?
At the technical level, these are precisely the questions with which the legal and conventional framework of international monetary relations is concerned.
The efficiency of the monetary order will depend directly on how these questions are answered.
However, the efficiency of the monetary order has of course the traditional concern of economists. In their analytical discussions, economists have distinguished three separate (though interrelated) structural problems of international monetary relations.
These are: adjustment, liquidity, confidence. Every international monetary order is challenged to find solutions to this crucial triad of problems, which together condition the financial conduct of nations.
The liquidity and confidence problems are mainly concerned with the choices that governments make between adjustment and financing.