Guns and Money in the Open Economy: The Exchange Rate and the Demand for Arms Imports

Can monetary policy, and the exchange rate, affect military capability? If weapons systems are purchased on international markets, then a depreciating currency can reduce the import of arms, affecting the relative capabilities of military rivals. In this research note, we analyze the demand for arms imports using an error correction model. We show that arms are a “normal” good, with the quantity demanded directly related to price and with exchange rates serving as an instrument for price movements that are normally unobserved. Such price movements are increasingly important given currency volatility and a reliance on imported technology.