The role of monetary variables in the determination of the balance of payments. Theoretical analysis and empirical study: the Peruvian case
Chiappori de Mendoza, Ana G.
Huddle, Donald L.
Master of Arts
The purpose of the thesis is to place in adequate perspective the role of monetary variables in the determination of the balance of payments of less developed countries and particularly of Peru. The monetary approach to the balance of payments, which hypothesizes that in the long run the balance of payments is determined by the demand for and the supply of money, is examined and evaluated. Two groups cf empirical studies analyze the role of monetary variables in balance of payments determination. The first group tests the long run propositions of the monetary approach by the estimation of the "reserve flow regression," which relates changes in international reserves to changes in the demand for money and changes in domestic credit. The second group specifies and estimates econometric models which elucidate the short run process by which monetary variables affect the balance of payments. The review of earlier results obtained from the estimation of the reserve flow regression for various less developed countries and the results here obtained for Peru indicate that increases in the rate of growth of domestic credit (for a given rate of growth of the demand for money) generate international reserves outflows and that increases in the rate of growth of the demand for money (for a given rate of growth of domestic credit) determine international reserves inflows. These results, however, are insufficient to rule out the possible rejection of the monetary approach to the balance of payments. Estimation biases may be present. In addition, the reserve flow regression cannot differentiate between the predictions of the monetary approach and those of other theories of the balance of payments. Even though the proposition that the balance of payments is solely a monetary phenomenon is not accepted, the role of monetary variables in the determination of the balance of payments should not be underestimated. Several short run econometric models of balance of payments determination for various less developed countries indicate that exports, imports and short term capital flows respond to conditions in the domestic money market. An excessive monetary expansion will tend to lead to a deterioration in the balance of payments which will partially correct the disequilibrium in the money market by reducing the supply of money. The results of the estimation of a monetary model of determination of the Peruvian balance of payments indicate that an excessive expansion of domestic credit increases real aggregate expenditure, real income and prices in the short run, which affect real imports through the income and price mechanisms. Exports, however, are mostly autonomous to monetary shocks in the short run.