On the Concept of Foreign Exchange Multiplier—A Correction

In an earlier issue of this journal, Diamond [1] has arguedthat in develop¬ing countries increased imports may have an inflationaryrather than a defla¬tionary impact on the economy. His reasoning isbased on the fact that develop¬ing countries are faced with shortsupplies of imported inputs and not with a deficient demand. An increasein the imports of intermediate goods results in increased production andhigher G.N.P. The ratio of the increase in output to the increase in theimports is termed foreign exchange multiplier by Diamond. Diamond'sanalysis is quite useful as it enables one to determine the increase inoutput when foreign exchange constraint is relaxed in a developingeconomy. However, his analysis suffers from two problems. First, theassumption that all of the increase in foreign exchange will beallocated to the imports of intermediate goods is unrealistic. Second,there is a mathematical error in his Equation 6 when he divides theoutput vector by an imports vector. In this note, the assumption thatall of the increase in foreign exchange is allocated to the imports ofintermediate inputs is relaxed. Diamond's Equation 6 is corrected. It isfurther shown that for the computation of a foreign exchange multiplierfor the economy as a whole one does not need inter-industry matrix andthat information regarding the value added per unit of gross output issufficient.