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Unit 12 : Equilibrium and Disequilibrium in BOP
Without growth in the domestic source component, the stock of foreign exchange reserves would Notes
grow without limit as the countrys income and demand for money grows. This growth of
reserves must be controlled because short-term foreign government securities, the main assets
held as official reserves, are not a particularly good form for a country to hold large quantities
of its wealth. Given the countrys employed capital stock and the amount of wealth its residents
possess, the bigger the fraction of that wealth held in the form of short-term foreign assets, the
smaller will be the fraction held in equity and fixed income claims against domestically employed
capital which will yield much higher returns than the treasury bills that form the greater part of
the stock of official foreign exchange reserves.
The Canadian period of fixed exchange rates between late-1962 and mid-1970 provides an interesting
example of the growth of official reserves in relation to base money. Figure 12.1 presents the two
series expressed in millions of Canadian dollars.
5000
Millions of Canadian Dollars 4000 3000 2000
1000 Base Money
Foreign Exchange Reserves
0
1964 1966 1968 1970
Monthly
Figure 12.1 : Canada : Base Money and Foreign Exchange Reserves
Base money grew steadily in Canada except for a slight dip in late-1967 and early 1968. The Canadian
stock of official foreign exchange reserves, on the other hand, declined very gradually until late-1967
and then trended upward thereafter, increasing sharply in 1970. The month-to-month changes in
Canadian base money and official foreign exchange reserves are plotted in Figure 12.2.
400
Base Money
300 200 Foreign Exchange Reserves
Millions of Canadian Dollars 100 0
–200 –100
1964 1966 1968 1970
Month-to-Month Changes
Figure 12.2 : Canada : Month-to Month Changes in Base Money and Official Reserves
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