Fourth Quarter 1993
Federal Reserve Bank of Dallas

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The Theory and Practice of Free Trade
David M. Gould, Roy J. Ruffin, and Graeme L. Woodbridge

David M. Gould, Roy J. Ruffin, and Graeme L. Woodbridge argue that free trade is supported both by economic principles and evidence from countries that have followed open market policies. The authors demonstrate that the countries whose markets are the most open have higher real output and economic growth.

The authors show that many arguments for protection obscure the benefits countries derive from international trade. High-wage countries not only can compete with low-wage countries, they dominate the world economic stage. Trade deficits or surpluses are not inherently bad or good, but rather reflect a country's consumption and investment decisions over time. Moreover, there is no evidence to suggest that imports cause systematic unemployment or that exports create systematic employment. The authors explain why industrial policies and protection designed to promote particular industries usually backfire; trade policies usually reflect the lobbying efforts of the most vocal and powerful self-interest groups.

Rethinking the IS in IS-LM: Adapting Keynesian Tools to Non-Keynesian Economies, Part 2
Evan F. Koenig

The IS-LM diagram was developed as a tool for analyzing Keynesian economies-economies with sticky prices and myopic households. In Part 1 of this article, Evan Koenig showed how a graphical apparatus similar to the traditional IS-LM diagram can be used to analyze economies with a fixed capital stock and optimizing, forward-looking households. Part 2 extends the earlier analysis to an economy with capital investment. As before, an expectations-augmented variant of the IS-LM model is found to include a popular real-business-cycle model as a special case. Thus, the IS-LM diagram has wide applicability as a pedagogical device and as a framework within which to discuss policy.

High Inflation: Causes and Consequences
John H. Rogers and Ping Wang

Using evidence from seven hyperinflationary episodes in four Latin American countries in the second half of the 1980s, John Rogers and Ping Wang examine the causes and consequences of high inflation. The article emphasizes four issues: the welfare costs of inflation and real costs of stabilization, the common features of the chronically high inflations experienced in Latin American countries, the main causes of high inflation, and the widely different outcomes of several stabilization programs.

Rogers and Wang find that the welfare costs of even moderate periods of inflation may not be negligible, whereas the adverse macroeconomic effects of stabilization efforts are mostly temporary. The authors show that the spiral-like adjustment of the government budget and monetary growth may result in a high-inflation trap. The main causes of chronically high inflation include continuous fiscal-monetary extension, productivity slowdown, systematic undervaluation of the domestic currency, and diminished credibility of anti-inflation policies. Successful stabilization, in essence, results from budgetary adjustment, market liberalization, and the adoption of a nominal anchor (such as the nominal exchange rate), all of which ensure credibility of the public authorities.