Monetary Approach to the Balance of Payments

Abstract

The monetary approach to the balance of payments is an analytical formulation which emphasizes the interaction between the supply and the demand for money in determining the country’s overall balance of payments position. It could be seen as an extension, to the case of an open economy, of traditional closed-economy monetary theory, which stresses the stability of the money demand function and considers the various channels through which changes in the money supply affect the economy. If changes in the money supply are not matched by equivalent changes in demand, then a stock disequilibrium arises. In responding to the stock disequilibrium, individuals alter their spending patterns. These adjustments are subject to the budget constraints which link the excess flow supply of money to the corresponding excess flow demand for goods and services. In a closed economy nominal income rises and interest rates may change so as to eliminate the disequilibrium in the money market; the increase in prices, and possibly output, in conjunction with the change in interest rates, raises the nominal demand for money to a level equivalent to the rise in the nominal money stock.