THE MONETARY APPROACH TO THE BALANCE OF PAYMENTS: A CRITICAL APPRAISAL OF SOME EMPIRICAL EVIDENCE
| DOI | http://doi.org/10.1111/j.1468-0084.1984.mp46004004.x |
| Published date | 01 November 1984 |
| Author | Mark Taylor,Aris Spanos |
| Date | 01 November 1984 |
OXFORD BULLETIN OF ECONOMICS AND STATISTICS, 46, 4 (1984)
l3O5-9O49 3.00
THE MONETARY APPROACH TO THE
BALANCE OF PAYMENTS: A CRITICAL
APPRAISAL OF SOME EMPIRICAL EVIDENCE
Ans Spanos and Mark Taylor*
I. INTRODUCTION
The main purpose of the paper is to reconsider some empirical evidence
relating to the Monetary Approach to the Balance of Payments (MABP).
In particular the modelling and statistical analysis of the reserve-flow
equation under fixed exchange rates is critically appraised.
In the MABP literature there has been an uneasy feeling that the
empirical model used for the reserve-flow equation might he dominated
by a money stock identify. For example Johnson (1977, p. 13) argues:
'First, there is a dangerous temptation to test and confirm the
monetary approach spuriously, by verifying statistically the tauto-
logy that an increase in domestic money must be provided either
by domestic credit creation or by reserve acquisition.'
Magee (1976, p. 586) suggests that the estimated equation might be
'... dominated by the central bank balance sheet identity .
A similar feeling is also expressed by Frenkel et al. (1980). The aim of
this paper is to argue that this is indeed the case with most estimated
reserve-flow equations. These studies reproduce in effect the original
money stock identity in disguise.
In Section II the derivation of the reserve-flow equation under fixed
exchange rates is considered and the model critically appraised. In
Section III the argument relating to the empirical evidence is illustrated
using quarterly data for the UK. Section IV concludes the discussion
with some suggestions on how to model the reserve-flow equation in
order to avoid the problems raised. In the appendix some of the points
made in the main body of the paper are elucidated by ITlCflS of a more
formal argument.
II. MODELLING THE FLOW OF RESERVES
A major premise of the MABP is that under fixed exchange rates excess
demand or supply of money in the domestic market will directly affect
* We are most grateful to Ron Smith for some stimulating discussions on this topic. We
would also like to thank David Hendry for some very useful comments and suggestions. The
usual disclaimer applies.
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