Gottfried Haberler, The Market for Foreign Exchange and the Stability of the Balance of Payments: A Theoretical Analysis (1949)

Haberler’s theoretical journal article examines when currency depreciation improves a country’s balance of payments and when it instead enlarges the deficit. Its nine sections move from exchange-market stability through the derivation of currency demand and supply, to elasticity conditions, unequal trade balances, and monetary repercussions. The central argument is that exchange-market behavior cannot be inferred directly from consumer demand for traded goods: several distinct layers of demand and supply intervene. Haberler isolates the initial effect of an exchange-rate change in a two-country framework, postponing induced expenditure changes and excluding speculative dynamics.

The opening analysis defines stability through the response to excess demand for foreign currency. With downward-sloping demand and upward-sloping supply, a rise in the foreign currency’s price eliminates the shortage. A downward-sloping supply schedule can produce instability if it is less steep than demand: depreciation then intensifies the deficit it was intended to correct. Stability alone, however, does not establish the practical adequacy of exchange-rate adjustment.

It would be sufficient for that purpose to demonstrate that demand and supply curves are steep (inelastic).

Small disturbances could then require large exchange-rate movements, with potentially substantial changes in the terms of trade. Haberler therefore distinguishes the direction of adjustment from its magnitude: a balance may respond normally but too weakly for depreciation to be a convenient corrective.

Sections III and IV construct exchange-market schedules from aggregate import and export markets. Domestic import demand and export supply are initially held fixed in home-currency terms. Depreciation lowers import quantities and raises export quantities, but its effects on prices and monetary values depend on the currency of measurement. Import expenditure falls in foreign currency, whereas export receipts may rise or fall according to foreign demand elasticity. In domestic currency, export receipts rise, while import expenditure depends on domestic import-demand elasticity. These distinctions explain why physical trade adjustment does not necessarily imply an improvement in the monetary balance.

Section V revisits the condition commonly associated with Lerner: the sum of demand elasticities for imports and exports must exceed unity. Haberler identifies its restrictive assumptions—initially balanced trade and infinitely elastic supplies. When the condition is instead expressed through demand elasticities for the two currencies, supply responses are already incorporated. Translating demand for one currency into supply of the other connects the elasticity rule to ordinary exchange-market stability.

Still, it is useful inasmuch as it helps us to realize that instability in the exchange market implying perverse influence of currency depreciation, is possible even if all markets for exports and imports each are in stable equilibrium.

This is the article’s crucial conceptual separation: stable commodity markets need not aggregate into a stable currency market. Incorporating all four trade elasticities also shows that a sum of import and export demand elasticities greater than unity is sufficient, but not necessary, for normal adjustment. Sufficiently low supply elasticities can preserve stability even when the demand-elasticity sum falls below unity.

Section VI addresses the apparent conflict between theoretical expectations of elastic international demand and statistical findings of weak responses. Import demand is the excess of domestic demand over domestic supply; export supply is the excess of domestic supply over domestic demand. A price change therefore operates through both consumption and production, making these residual trade schedules more elastic than their underlying domestic counterparts.

Hence import demand and export supply curves are the more elastic the longer the reaction time which is allowed.

Adjustment also changes the composition of trade: previously untraded goods may become exports, while other goods leave the import list. Estimates confined to existing commodities or short observation periods can miss these responses. Haberler’s confidence is qualified by economic structure. Specialized primary-producing countries, illustrated by Brazil’s dependence on coffee, face greater risks of inelastic demand than diversified industrial economies.

Section VII modifies the elasticity conditions when exports and imports are unequal. Their relative initial values must weight the relevant responses. Currency denomination now matters decisively: depreciation can reduce an import surplus measured in foreign money while enlarging it in domestic money. For the contemporary “dollar shortage,” the foreign-currency balance is the relevant measure. A larger initial import surplus increases the weight of the import-expenditure response and can make improvement more likely, although it also heightens vulnerability to adverse price changes. Services and interest payments belong within this broader accounting.

Section VIII returns to the fixed-schedule assumption. An improved current balance can expand expenditure through the foreign-trade multiplier; credit expansion and wage adjustment can reinforce that effect. Under unemployment, output and employment may rise, whereas near full employment price increases can undo the external gain. Observed failure after depreciation may thus reflect shifts of the schedules rather than perversely low elasticities.

But would there be an improvement provided inflation is avoided? This is not only a legitimate but the most relevant question in that connection.

The concluding section presents the analysis as the first step toward a fuller balance-of-payments theory. Its lasting contribution is a hierarchy connecting domestic commodity schedules, residual trade schedules, trade aggregates, and currency markets. Keeping these layers distinct clarifies both what elasticity conditions establish and why monetary policy, adjustment time, and changing trade composition remain indispensable to interpreting depreciation’s actual effects.