The Absorption Approach to the Balance of Payments
The weaknesses of the elasticity approach to balance-of-payments adjustment can be summed up by saying that it is partial-equilibrium analysis; it ignores supply conditions and cost changes as a result of devaluation; and it tends to neglect the income and expenditure effects of exchange-rate changes. At the very least the elasticities used by the approach ought to be total elasticities, not partial elasticities. But taking the total elasticities of exports and imports is tantamount to examining the relation between the balance of payments and the functioning of the economy as a whole. This insight is the starting-point of the absorption approach to the balance of payments which was originally developed by Alexander (1952) and subsequently elaborated on by Johnson (1958), though, arguably, with misleading conclusions.1
KeywordsMonetary Policy Money Supply Excess Supply Marginal Propensity Domestic Money
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