ARE CURRENCY DEVALUATIONS NECESSARILY BAD - NEW KEYNESIAN ARGUMENTS FOR INTERVENTION RATHER THAN MONETARIST ORTHODOXY

Traditional monetarist thinking argues that currency devaluations are counterproductive because they generate additional inflationary pressu res. Expectations that future inflation will have to be accommodated u ndermine the credibility (and hence effectiveness) of current monetary policies. However, these arguments neglect the impact on activity lev els and whether there is spare capacity. Hard (or contractionary) mone tary policies in recession will cause an equal loss of credibility wit h investors and forward-looking consumers who will make their expendit ures elsewhere. These are therefore circumstances when currency devalu ation could be helpful, and without inflationary consequences if risin g productivity and spate capacity offset import price rises. Moreover, devaluation within a currency bloc can leave the effective exchange r ate unchanged if the bloc is rising against external currencies; while boosting demand at the same time if the within-bloc import/export ela sticities are higher than those outside. This paper tests these argume nts econometrically, and shows that the conditions for a successful St erling devaluation did exist in 1992.