Knowledge that Transforms

Helmut A. Hagemann has provided a useful analysis of reserve policies of central banks in his recent article in this Review. However, I am afraid that the unavailability of data has led him into wishful thinking about the value of the dependent variables in his exercise. I refer specifically to the use of (FIR)j, foreign exchange of country i, relative to total reserves of country i as a proxy for (D/R) i;1 dollar-denominated foreign exchange of country i, relative to total reserves of country i. Let us consider what distortions may arise from using (FIR), where (DIR)i ought to be. Let:

I cannot agree with Bela Balassa that my conclusions change if different definitions are used. The conclusions following from definitions are conclusions, not mine. The issue is whether the conclusions are interesting and correct. A careful reading of my paper will indicate that in all cases I look at the second-best optimum for a given consumption distortion. For the case where the intermediate good was not prodtuced at home, it was shown that one can find a nominal tariff on the intermediate good such that a second-best optimum can be achieved for a specified consumption distortion. For the case where the intermediate good was produced at home, it was impossible to find a tariff on the intermediate good that would lead to a secondbest optimum. Balassa, on the other hand, looks at the second-best solutions for any consumption distortion, including the absence of a consumption distortion. It is not surprising, therefore, that he reaches conclusions. But the new conclusions reinforce, rather than contradict, my results. Assume a world in which ad valorem import tariffs and export subsidies (collectively referred to as tariffs) are the only impediments to the competitive adjustment of markets, all goods are traded, and the prices of all goods are fixed on world markets. If all intermediate goods have fixed coefficients of production, the production functions involving the primary factors and the supplies of those factors can be used to construct the gross transformation function T(X1,... Xm) = 0, where Xi = the amount of the ith good produced at home. For a given consumption distortion, a second-best optimum requires that production be at the free trade production point: (1) T/lTk == PP l' i k; i = 1, . . ., it, where Pj' is the price of good j net of the cost of intermediate goods. If zi and Zk are the Barber-Corden-Johnson-Balassa effective tariff rates on goods i and k which measure the percentage changes in the domestic value-added of the two goods, then under comnpetition it will happen that