OVER THE YEARS the Fund has endeavored to develop various models that would indicate, if only in an approximate way, the likely relationship between credit creation in a member country and its balance of payments. One characteristic of this effort at model building has been that it has aimed at simple models. The advantage of simple models, if they are well designed, is that they will bring out clearly the main relevant features and interrelationships of a particular economy and thus point to certain major relationships important for policy purposes. More refined models may take into account a much wider set of variables and relationships, and may thus, in principle, serve to answer a wider variety of questions over a broader range of circumstances; but in practice such models often fall between two stools, being at the same time insufficiently articulated to catch aspects of reality that were not specifically considered at the time of their construction and too complicated to be readily tapped for significant answers, except perhaps by the most skilled operator.
IN DISCUSSING MONETARY MEASURES for demand management, two interrelated questions are usually raised: first, how to evaluate the impact of changes in monetary variables on aggregate demand and, second, which monetary variable is appropriate from the viewpoint of policy. 1 In examining these questions, but mainly the second, the paper concentrates on the choice between money and credit as the policy-controlled variable—that is, whether the authorities should act (place a ceiling) on credit or on money when they intend to regulate pressures on demand, and particularly pressures on the balance of payments. 2
In comparison with other problems of development the question of the proper management of the economy’s money may at first glance appear to be of secondary importance. Yet the history of money is full of examples of monetary disorders which have nullified the economic efforts of a whole nation for months and years. Even in less extreme cases inappropriate monetary policies may deprive an economy of part of the fruits of its development effort, no matter how excellent the development program is in other respects. For this reason it is important to incorporate considerations of monetary management into the general economic development plans. This in turn requires a quantitative assessment of the relations between money and other economic magnitudes.
AS THE FIRST STAGE in the development of a monetary analysis of income and imports, an earlier study 1 derived a simple theoretical model of countries’ economies in which monetary and balance of payments developments were integrated. That study led to certain general conclusions about the effects of credit expansion and of changes in exports that, it was believed, would be helpful in understanding the developments with which one is often faced in the study of individual countries. For the most part, the conclusions did not involve the use of numerical coefficients pertinent to particular countries.
THE AIM of this paper is to inquire into the extent to which movements in the value of imports can be accounted for statistically in terms of the model described in two earlier studies in Staff Papers,1 to evaluate the results, and to consider whether the facts suggest any supplementary elements of explanation. Reference will be made throughout to Chart Series II in the second of the earlier articles, as well as to Table 1 in this paper, covering approximately the same set of countries.2
IN THIS PAPER a very simple macromodel will be constructed as a basis for examining the role of monetary variables in the balance of payments. The model is basically Keynesian. It is expressed in real terms, the behavioral relations are simple and lagless, the interest rate is the only link between monetary and real variables, and monetary variables are treated as autonomous (under the control of the authorities). All functional relations will be assumed to be linear for simplicity.
THE VIEW THAT THE BALANCE OF PAYMENTS is essentially a monetary phenomenon—in other words, that the demand for and supply of money play a fundamental role in its determination—has recently gained considerable appeal in the literature.1 In the framework of the monetary approach, the balance of payments position of a country is considered to be a reflection of decisions on the part of its residents to accumulate or to run down their stock of money balances. It is this process of adjustment to the desired stock of money balances that results in balance of payments deficits and surpluses.2 If a country is small and there is perfect mobility of capital and goods (that is, at a given level of world interest rates and prices, a country can import or export goods and financial assets without affecting their prices), domestic prices and interest rates are determined exogenously.3 In this case any excess demand for money balances that emerges must be satisfied either from domestic sources or from abroad. Since prices and interest rates cannot change, and if the domestic component of the money stock is constant, this excess demand will result in an increase in international reserves (i.e., there will be a balance of payments surplus). This increase in international reserves may come about through an improvement in the trade balance, or the capital balance, or both. The monetary approach deals only with the ultimate effect and not with the channels through which this effect occurs.