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The Balance of Payments Adjustment Mechanism in a Rational Expectations Equilibrium

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Abstract

This paper provides a choice theoretic, general equilibrium account of the balance of payments adjustment process and the determination of national price levels in a world comprised of countries populated by rational households. Balance of payments adjustment dynamics arise in the equilibrium of this model from the precautionary saving behavior of risk-averse households who self-insure against random productivity fluctuations by accumulating, via balance of payments surpluses in productive periods, buffer stocks of domestic money which can be drawn down to finance payments deficits, and thus a less variable profile of consumption relative to output, when productivity is unexpectedly low. Precautionary saving is shown to exhibit the partial-adjustment-to-target behavior typically postulated in the monetary approach literature. The existence of a rational expectations equilibrium in which the distribution of international reserves among central banks is stationary is established.

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File URL: http://cowles.econ.yale.edu/P/cd/d07b/d0769.pdf
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Paper provided by Cowles Foundation for Research in Economics, Yale University in its series Cowles Foundation Discussion Papers with number 769.

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Length: 25 pages
Date of creation: Apr 1985
Date of revision:
Handle: RePEc:cwl:cwldpp:769

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Postal: Yale University, Box 208281, New Haven, CT 06520-8281 USA
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Web page: http://cowles.econ.yale.edu/
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Postal: Cowles Foundation, Yale University, Box 208281, New Haven, CT 06520-8281 USA

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Keywords: Balance of payments; adjustment dynamics; price levels;

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  1. Lucas, Robert E, Jr, 1980. "Equilibrium in a Pure Currency Economy," Economic Inquiry, Western Economic Association International, vol. 18(2), pages 203-20, April.
  2. D. K. Foley & M. F. Hellwig, 1973. "Asset Management with Trading Uncertainty," Working papers 108, Massachusetts Institute of Technology (MIT), Department of Economics.
  3. Dornbusch, Rudiger, 1973. "Devaluation, Money, and Nontraded Goods," American Economic Review, American Economic Association, vol. 63(5), pages 871-80, December.
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