Asymmetries in Price Responses and Ratchet Effects

The notion that asymmetries in price behaviour and ratchet effects of some sort have a profound influence on the world price level has rarely been absent from the discussion of inflation propensity of alternative exchange-rate regimes. Haberler (1974) was echoing a recurrent theme when he theorised that the fixed exchange-rate regime had an inherent inflationary bias, because the price level in surplus countries tended to rise due to reserve accumulation, while the rigidity of money wages prevented a fall in the price level in deficit countries.1 A similar argument, based on different types of asymmetries and ratchets in a floating exchange-rate regime, has recently gained currency. The new conjecture, commonly referred to as the Mundell—Laffer hypothesis, asserts that due to asymmetrical price response to exchange-rate changes in depreciating and appreciating countries, a floating exchange-rate regime is liable to impart an inflationary ratchet to the world price level. Various interpretations and criticism of the Mundell—Laffer proposition are contained in Wanniski (1975), Mundell (1976), Claassen (1976), Corden (1976), Crockett and Goldstein (1976), Kreinin (1976), Goldstein (1977, 1980), and Kreinin and Officer (1978).