External Imbalance Models

In this chapter, we have covered external imbalance models by opening the discussion with the price-specie flow mechanism of the classical tradition. The price-specie flow mechanism is the adjustment mechanism which automatically triggers off an outflow (inflow) of gold or bullion or international reserves under the IMF to correct balance of payments or trade deficits (or surplus) under the gold standard by market forces of supply and demand. It results in prices of balance of payments or trade deficits (or surplus) country’s falling (or rising). The elasticity approach to the balance of payments problem assumes unemployment in the country, and estimates of exports and imports of the country of interest versus the rest of the world. It then computes variants Marshall-Lerner condition criteria to determine the success of devaluation or depreciation policy to the country of interest. The J-curve traces out the success and duration of the said policy. The exchange market pressure model is used to model the performance of exchange rate policy for countries. It is also used to determine which exchange rate regimes can best suit the country facing balance of payments or trade deficit problems. The exchange market model can be used to study the balance of payment disequilibrium problem of a country under either a flexible or fixed or managed floating exchange rate regimes. It is also used to determine optimal exchange rate regimes of a country. Empirical results of exchange rate regimes are discussed in the chapter.