The Classical Transfer Problem and the Theory of Foreign Exchanges

This essay analyzes a model that, for over a hundred years, has lurked behind discussions of the transfer mechanism and the theory of foreign exchanges, yet has never been made explicit. The model originates with John Stuart Mill (1848, vol. II, book III, ch. XXI) and was developed by Taussig (1917, 1927), Keynes (1930), and Robinson (1937a) among others. It underlies what Samuelson (1952) called the ‘orthodox presumption’ in the theory of the transfer problem; and it also lies at the basis of the simplest expositions of the so-called ‘elasticity approach’ to the balance of payments. Of course, one cannot say definitely that the model presented here faithfully represents the notions adhered to only subconsciously by all these writers; but it does reproduce (and make plausible) some of the most prominent propositions associated with these doctrines, as well as expose (and explain) some of the fallacies involved in their misapplication and misinterpretation.