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Unit 13: BOP Adjustment : Monetary Approach

rate and domestic credit had negative relationship with net foreign asset with statistically Notes
significant coefficients. In addition, the result established a positive relationship between log of
GDP and net foreign asset with statistically significant coefficients.
• A major policy implication of this study is that the monetary approach to the balance of payments
holds in the WAMZ countries studied, since growth in domestic credit is an important
determinant of their balance of payments position. Therefore, a tight rein on domestic credit
creation is a necessary condition for maintaining stability in the balance of payments over time.
Thus, monetary authorities should pay special attention to domestic credit creation when
controlling the country's balance of payments. It is important that the country achieves sufficient
economic growth through money demand to correct the balance of payments deficit. Authorities
of the WAMZ countries should also look at the increased budget deficit, which is mostly financed
through borrowing from the central bank. The expansion in the fiscal deficit caused the increases
in domestic credit.
• Another policy implication is the need to manage domestic liquidity wisely in view of the
tremendous pressure on the balance of payments of excess money. A determined effort to
mobilize resources through private saving and the implementation of a prudent fiscal policy
through efficient collection of tax revenues, rationalization of government expenditure towards
growth enhancing and poverty reduction programmes will also enable the government to
pursue its development programs without having to rely on the monetization of its budget
deficit.
13.4 Key-Words

1. Monetary Approach : A framework for analyzing exchange rates and the balance of payments
that focuses on supply and demand for money in different countries.
2. Deficit : A deficit is the amount by which a sum falls short of some reference
amount. In economics, a deficit is a shortfall in revenue
13.5 Review Questions

1. What is the monetary approach to BOP Adjustments?
2. Discuss the model of Monetary approach.
3. Distinguish between elasticity and absorption approach.

Answers: Self-Assessment

1. (i)(d) (ii)(d) (iii)(a) (iv)(a) (v)(a)
(vi)(c) (vii)(c)
13.6 Further Readings

1. Alexander, S. S., “Effects of Devaluation on the Trade Balance,” IMF Staff Papers,
Vol.2, April 1952, reprinted in H.G. Johnson and R. E. Caves (eds). Readings in
International Economics, (Richard D. Irwin, Homewood, III., 1968).
2. Chacholiades, M., International Economics, (McGraw-Hill, New York, 1990), Chs.
12-15 and 19.
3. Demburg, Thomas, F., Macroeconomics : Concepts, Theories and Policies, (McGraw-
Hill, New York, 1985). Chs. 15 and 16.
4. Dombusch, D, Fischer, S., and Startz, R., Macroeconomics, (McGraw-Hill, New
York, 7th edn.), Ch. 12. International Monetary Fund (IMF), Balance of Payments
Mannual, 4th Edn.(1977).

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