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Unit 13: BOP Adjustment : Monetary Approach

under fixed and flexible exchange regimes. He found that an increase in domestic credit or money Notes
stock leads to external reserves outflow or adverse balance of payments during the fixed exchange
rate regime. But in the flexible exchange rate era, an increase in domestic credit brings about exchange
rate depreciation. Using data for 1960-1995, Jimoh (1990) also found that the monetary approach is
relevant in analyzing balance-of-payments adjustments in Nigeria.
The empirical results validate the MABP in Zimbabwe. The implication of such result is that money
played a significant role in the determination of deficits in the balance of payments. In a related
development, Coppin (1994:83) carried out a study for Barbados to test the validity of the MABP. It
was evident from his results that the ?degree of openness of an economy? played a particularly
important role in determining international reserves. He found strong evidence in support of the MABP
in Barbados. Specifically, the result revealed that expansionary fiscal policy played a vital role over
monetary factors in determining international reserves. Furthermore, Aghevli and Khan (1977) performed
an empirical test on the MABP for 39 developing countries and found highly significant results,
maintaining that the mechanisms underlying the MABP held strongly for these countries.
Lachman (1975) conducted a study to test the validity of the MABP for South Africa. His results
found strong evidence in favour of the MABP, and concluded that monetary authorities would
definitely be able to predict the extent to which increases in money supply would augment imports.
Leon (1988), also examined the applicability of the MABP in Jamaican. He used the reserve-flow and
sterilization equations using both single and simultaneous equations. The results found strong evidence
in favour of the reserve-flow equation, and that the MABP's predictions were not rejected. The results
also revealed that monetary authorities were in fact sterilising reserves in Jamaica. Watson (1990),
also conducted a study on Trinidad and Tobago in assessing the MABP, using data for the period
1965-1985. The results did not find any support in favour of the MABP, indicating that balance of
payment problems in Trinidad and Tobago is not a monetary policy issue.
In summary, there is convincing evidence that the MABP in fact is an important concept In the
literature and an unresolved issue. While some studies found evidence of the MABP (see Lachman
(1975), Dhliwayo (1996)), others including Watson (1990), did not found any support in favour of the
MABP. Most parts of the empirical literature were based on the ?reserve-flow equation', where a
country's international reserves, or the rates of change in reserves, are regarded as the dependent
variable. On the other hand, the independent variables vary in the different studies. They can include
domestic income, prices, the interest rate, government expenditure, money multiplier, money stock,
the exchange rate, and demand for nominal and real money balances. Thus, given the conflicting
evidence in the literature and the prevalence of the BOP deficit in the WAMZ countries, it is necessary
to undertake an empirical study in order to validate the MABP.

Dhliwayo (1996) used data for the period 1980-1991 to investigate the MABP in Zimbabwe.
His findings indicate a one-to-one negative relationship between domestic credit and the
flow of international reserves.

Self-Assessment

1. Choose the correct options:
(i) Balance of Payments equilibrium means
(a) the balance of trade equals zero
(b) the current account balance equals zero
(c) the capital account balance equals zero
(d) the current account balance is exactly offset by the capital account balance

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