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BALANCE OF PAYMENT DETERMINATION: THE MONETARY APPROACH.

BALANCE OF PAYMENT DETERMINATION: THE MONETARY APPROACH.

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BALANCE OF PAYMENT DETERMINATION: THE MONETARY APPROACH.

Chapter one

1.1. HISTORICAL BACKGROUND OF THE STUDY

The monetary approach to balance of payments (MABP) has been a prevalent perspective in International Monetary Economics, and the theory is thought to have a lengthy history. Which may be traced back to the writings of classical economists who proposed an integrated global capital market and mobility?

It is associated with the origins of balance of payments theory in David Hume’s work, notably this hypothesis of price-specie-flow mechanism (Johnson, 1976).

While criticising mercantilism’s goal of accumulating precious metals, David Hume pointed out that a country’s money supply would be automatically adjusted to meet demand.

In Hume’s analysis, this adjustment occurs through surpluses and adjustment deficits in the balance of payments caused by changes in relative national money prices.

However, while heavily influenced by Hume’s theory of balance of payments and this analysis of price-specie flow mechanism, the monetary approach emphasises monetary considerations in the interpretation of external balance problems rather than changes in relative national price levels (Dornhusch and Fischer, 1990, 764).

Nigeria’s balance of payments account has fluctuated between boom and disaster since political independence. The boom was brief and was mostly caused by an exceptional surge in oil prices in 1973 and 1974.

Aside from this period, Nigeria has continued to face major challenges. In the balance of payments position, the problem worsened in the early 1980s.

From an overall surplus of roughly N2A billion in 1980, Nigeria’s balance of payments saw continuous deficits of (N3 billion), (Nl.4 billion), and (0.3 billion) in 1981, 1982, and 1983, respectively.

Internal reasons contributing to Nigeria’s negative balance of payments position include high demand for foreign products, a heavy dependency base, political instability, and structural rigidities in the local manufacturing process.

The flaws in domestic macroeconomic policy have contributed to the situation. Furthermore, the trade and exchange rate policies implemented during the 1970s and early 1980s oil boom failed to create the necessary incentives for earning or saving foreign exchange.

Rather, they caused various macroeconomic distortions and entrenched import-oriented consumption and manufacturing habits in Nigeria, hence widening the trade gap.

In terms of the monetary approach to balance of payment under a fixed exchange rate regime, this research focused on the impact of changes or growth in the determination of money demand, as well as the domestic component of money supply, on changes or growth in foreign reserves.

The findings of these research generally confirm the principles of the monetary approach. For example, Courechence and Youssefs’ (1967) study of the relative influence of imports and money supply on demand foreign exchange reserves for a group of nine countries (Switzerland, Netherlands, Denmark, Sweden, Germany, Belgium, Italy, Japan, and Australia) found that money supply is more important than imports in determining the level of foreign reserves.

Their empirical findings show that money supply and long-term interest rates influence the demand function for particular countries’ foreign exchange reserves.

Based on their research, Courchence and Youssef believe that “the application of monetary theory concepts to the sphere of international payments can be quite successful.

The fundamental principles of the monetary method can be found in the writings of Frenkel and Johnson (1976), Musa (1974, 1976), and Johnson (1958, 1972, 1976a, 1976b, and 1977). Coppock (1978), Melvin (1984), and Uddin (1985).

Other contributors to the development of the monetary approach to balance of payments (MABP) theory include Mundell (1968), Dornbusch (1971), Tsiang (1977), and Bilson (1978).

The MABP’s primary thesis is that external balance difficulties are mostly (but not exclusively) monetary in nature. As a result, supporters of the monetary method say that:

“Balance of payment issues in a monetary environment should

be examined using models that clearly specify monetary behaviour.

and link it with the real economy rather than through models.

that focus on genuine connections and real monetary behaviour as a byproduct of actual behaviour.”

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