ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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Maxi Devaluation and Contraction

THIS is in response to Pronab Sen's reply (EPW, December 14, 1996) to my observations (EPW, November 23,1996) on his lucid exposition 'Cooper's Contractionary Devaluation Hypothesis: A Note' (EPW, July 27, 1996). My main argument was not to show that "contractionary devaluations, at least in the Cooper sense, are at best a curiosm". In fact, I appreciated Sen's analysis that with trade deficit, if the home good and imports are gross complements in consumption, it is possible for the small devaluations to be contractionary. It is also clear that I am in full sympathy with Sen's objective of investigating only the necessary conditions under which devaluations could turn out to be contractionary in the Cooper sense. However, my main point was that Sen's generalisation of these results from his framework to include the case of 'maxi' devaluation requires abnormal demand and supply conditions to be assumed. Sen (EPW, December 14) does not agree with this point because he finds my Figure 1 to be "fundamentally incorrect or, at best, incomplete" since I had "considered only the price effect of a devaluation but not its income effect". He then redraws the figure with exogenous exports (X0) explicitly introduced along with imports (M0) to form a trade deficit. He then goes on to 'show' that my argument, that contractionary maxi devaluations are incompatible with a U-shaped PCC, is not true. According to him the gross complementarity between the home good and imports is not required over the whole range but only within the range defined by the trade deficit relative to the level of imports for the 'maxi' devaluations to be contractionary. And argues Sen, "even in an inward-oriented country like India, this proportion has rarely crossed 20 per cent, and it is usually even smaller in the more open economies of Asia, Africa and Latin America including those which have raced serious balance of payments crises".

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