The Monetary Approach to the Balance of Payments

Abstract

As we said in the introductory remarks in Chapter 2, the focus of the monetary approach to the balance of payments is on the balance of payments as a whole (the current and the capital account) so that a balance-of-payments disequilibrium is equivalent to a change in the level of international reserves. The essence of the argument is that balance-of-payments disequilibrium must be considered as the outcome of stock disequilibrium between the supply of and demand for money. Balance-of-payments difficulties are a monetary phenomenon which can be corrected by monetary adjustment. Traditional balance-of-payments adjustment policies can only be successful to the extent that they eliminate the stock disequilibrium between the supply of and demand for money. Let us develop a formal model of the monetary approach, and outline its assumptions, as a prelude to evaluating its usefulness in contributing to an understanding of balance-of-payments problems and their solution. The model outlined here draws on the presentation by Hahn (1977) in his review of the Frenkel and Johnson (1976) volume on The Monetary Approach to the Balance of Payments.