Research Discussion Paper – RDP 7707 Money and the Balance of Payments


This paper continues the process of hypothesis testing in the RBA76 model project. Several models of the interaction of monetary disequilibrium and the balance of payments which have been proposed in the literature are tested in a consistent framework, using models of both the U.K. and the Australian economies. The comparison of results obtained for different countries and different sample periods is of considerable interest.

Briefly, the tests confirm the importance of a direct effect of excess money on the balance of payments, although domestic effects of monetary disequilibrium are also important. The results are not completely unambiguous, but on balance the specification with a measure of flow disequilibrium in the money market supplementing the usual stock adjustment model of international capital flows seems the best on most criteria used in the paper.

The effects of excess money on domestic prices and output arise because the reactions of the balance of payments, while strong, are not sufficient to immediately remove monetary disequilibrium following a monetary disturbance. The results emphasise the need to use models which integrate closed- and open- economy monetary theory in any practical situation, and suggest ways in which this integration can be achieved.

The authors are grateful to several economists for helpful comments on an earlier version of the paper, and especially to Michael Danes, Michael Darby, Bob Hawkins and David Laidler. None of the above, nor our employer, is necessarily in agreement with the arguments or conclusions of the paper.