The Monetary Approach to the Balance of Payments links changes in international reserves (balance of payments) with the domestic credit policy. Alterations in the foreign exchange market equilibrium and disequilibrium positions are explained as an image of the behavior in the domestic money market. Now, this behavior must be analyzed in terms of a demand function and a supply function for domestic money. Our knowledge about the private demand far domestic money may be considered at least satisfactory; nevertheless, we know very little about the money supply function, particularly in the case of small open economies under fixed exchange rates. Once we incorporate the inside money and quasimoney into the .supply function, separating the money stock into a monetary base and a multiplier, a specification problem arises when the non-linear money supply hypothesis is used in the context of small open economies with fixed exchange rates. The problem is due to our ignorance about analytically meaningful ways to define the base, vis a vis the concept of money multiplier. This aspect, neglected by the literature, is discussed in this paper. Furthermore, we propose that if the domestic Central Bank's supply of credit is considered the relevant definition of "monetary base", the multiplier in such an economy will depend on the composition of the money stock between international reserves and domestic credit. Therefore, if the predictions of the Monetary Approach to the Balance of Payments are to hold, the long run steady state equilibrium value of the relevant monetary multiplier must be different with respect to its initial value, when the equilibrium in the money market is disturbed by means of a domestic credit policy. This result questions the validity of some explicit or implicit assumptions that have been used in relation to the money multiplier in certain papers dealing with the Monetary Approach to the Balance of Payments.
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Article provided by Instituto de Economía. Pontificia Universidad Católica de Chile. in its journal Cuadernos de Economía.
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Anatol Balbach & Albert E. Burger, 1976.
"Derivation of the monetary base,"
Review,
Federal Reserve Bank of St. Louis, issue Nov, pages 2-8.
[Downloadable!]
Albert E. Burger & Robert H. Rasche, 1977.
"Revision of the monetary base,"
Review,
Federal Reserve Bank of St. Louis, issue Jul, pages 13-28.
[Downloadable!]