| This dissertation develops and analyzes new types of consumption and investment functions. The main idea behind this research goes back to Sydney Alexander's (1952) income absorption approach argument. Based on this theory the only way devaluation could improve the trade balance is to reduce domestic consumption and increase domestic investment so that more could be exported, leading to an improvement in the trade balance.;The main reason for this was said to be due to the inflationary effects of devaluation. Specifically, Alexander argued that if wages do not adjust fully to inflationary effects of devaluation, producers who charge higher prices will gain at the expense of the workers whose wages are not caught up with inflation. This will lead to a transfer of income from workers with high Marginal Propensity to Consume (MPC) to producers with low MPC, resulting in a decline in aggregate domestic consumption. Considering the investment side, since the only rigidity in this theory is the long adjustment lag of wages behind prices, in the short run, the entrepreneurs might therefore gain profit at the expense of the wage earners. However, eventually in the long run the wages and prices catch up and wages rise, in order to restore the pre-devaluation wage-profit relationship. In the long run depreciation may not have any significant effect.;In this dissertation both consumption and investment functions, not only depend on changes in income and interest rate, but also on the exchange rate. To test Alexander's argument and investigate the effect of currency depreciation on consumption and investment, using the time series data and bounds-testing method, new models are estimated for a sample of 50 countries over a period of 1975--2006 for both the short run and long run. The results from estimating the consumption and investment functions support Alexander's argument in the short run for most of the countries in the sample. This is evidence of a significant effect of exchange rate changes on consumption and investment in the short run but not in the long run, and it is consistent with the expectation that wages do not adjust to inflation in the short run but they do in the long run. Or, on the other hand, it might support the idea that older sticky-price Keynesian models can be violated at least for the long-run models. |
