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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 country’s 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 country’s 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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