Testing the monetary approach to the balance of payments : a case study based on Jamaica

Leon, Hyginus Lambert (1986) Testing the monetary approach to the balance of payments : a case study based on Jamaica. University of Southampton, Doctoral Thesis.

Abstract

One of the aims of the International Monetary Fund (IMF) is the attainment of consistency in the balance of payments policies of its members. In pursuing that goal, the IMF has required many countries to undertake successfully stabilisation programs as a condition to maintaining access to its resources. The apparent lack of success of these stabilisation programs has led various authors to criticise the IMF for using incorrect diagnoses of the causes of balance of payments problems in formulating remedial programs. A key approach of the IMF - the Monetary Approach to the Balance of Payments - is examined both in its popular single equation formulation, using the fixed exchange rate case, and in a specific application of the theory to a simultaneous equation system. The emphasis is on investigating the adequacy of the postulated models through tests of subset restrictions on a less restricted model, and residual diagnostic analysis. The Reserve Flow and Sterilisation equation results indicate that the predictions of the Monetary Approach to the Balance of Payments are not wholly unsupported by the data. In particular, the offset coefficient attains its theoretical prior, and the sign predictions of output and price changes are upheld. However, sterilisation was found to have occurred during the estimation period. Further, unidirectional causality from domestic credit to international reserves, and the existence of a long run demand for money function were not rejected by the data. With regard to the specific application, a simultaneous equation model developed by Khan and Knight (1981) was estimated on Jamaican data using 1953-1981 data. The results pointed out the need for testing imposed assumptions as an integral part of model building. However, the model was seen as constituting a framework within which additional characteristics of the Jamaican economy could be integrated to enhance the overall performance of the model. In conclusion, the analysis indicated that, for the economy in question and the time period studied, the Monetary Approach to the Balance of Payments could be meaningfully utilised as a basis for the analysis of the observed data. Notwithstanding other approaches to external adjustment could also yield similar results.

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