The purpose of this paper is to present a monetarist interpretation of the Cooper paradox by integrating the tight money effect produced by devaluation into the disequilibrium open economy framework.
Our treatment begins from the utility maximization devaluation model, and is then extended to a two-country model of devaluation in which nominal wages and the price level are sluggish in the short run. Thus our model synthesizes the basic proposition of the monetary approach to devaluation with the disequilibrium microfoundation.
Our findings show that devaluation may improve the trade balance by depressing the domestic economy and inflating the price level. This contrasts sharply with the arguments of Meade-Tsjang (1951, 1961), but is totally consistent with the observations of actual devaluation experience in developing countries found in Cooper (1971), Krugman and Taylor (1978). Moreover, our model is theoretically different from that of Chen (1973, 1975), Chen and Tsaur (1981), Sieh and Mai (1979). Thus, although this paper may be cumbersome, it is still worthwhile for interested readers to focus on.
