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Final Term Paper

Final Term Paper

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Published by Nida Khan
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Published by: Nida Khan on Mar 28, 2014
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 Department of Economics
1
Chapter 1 Introduction
“Balance of payment” is the record of economic transaction of a country with the rest of
the world during a year. It mainly consists of three accounts; current account, capital account and reserve account. Balance of payment keeps the complete record of a country trade, net foreign asset, imports and exports of goods, financial transfer and financial capital. Simply it summarizes international transaction for specific period, mainly a year.
 
The method of analyzing the balance of payments is called the monetary approach to the  balance of payment. The monetary approach to balance of payment regards money as a stock, and argues that money stock can be changed through international reserve flows. It states that a fixed exchange rate system could work without having to resort to devaluation, provided a country has a sound monetary policy; thus, devaluation will only occur as a result of a failure of monetary policy (Umer, 2010). This argument stems from the fact that disequilibrium in the balance of payments is a temporary situation that will be corrected if
the “
money market is in equilibrium
” (
 Plessis, 1998). The monetary approach may be claimed to be compatible with absorption approach on the  proviso that the former stresses the need for equality in the demand for and supply of money, while the latter stresses the need for equilibrium in the market for domestic output, they differ however, on grounds that the monetary approach is a more general theory, since it explains the overall balance of payments (including the capital account), whereas the absorption approach is concerned mainly with explaining the current account (Akpansung, 1998).
 
 
 Department of Economics
2
Although the monetary approach has been commended for explaining the balance of  payments well, it has prompted criticism from other scholars as an approach that ignores other parts of international trade in determining the balance of payments. The MABP has  been blamed for disregarding the fiscal and real factors that influence changes in the  balance of payments, whilst concentrating only on monetary factors (Umer 
.,
2010) Contrary to these views, it can be stated that the monetary approach does not ignore these factors. Valinezhad (1992
) contends that “the MABP only asserts that the effect on the
 balance of payments of a higher rate of economic growth should be analyzed with the
tools of monetary theory”.
 
An enormous number of studies have emerged throughout the years testing the validity of the MABP empirically. There is credible evidence that the MABP in fact applies to small open economies with fixed exchange rates. Most parts of the empirical literature were based on
the „reserve
-
flow equation‟, where a country‟s international reserves, or the rates of change in reserves,
are regarded as the dependent variable. On the other hand, the independent variables vary in the different studies. They can include domestic income, prices, the interest rate, government expenditure, money multiplier, money stock, the exchange rate, and demand for nominal and real money balances (Ume
 ,
2010). The monetary approach to balance of payment provoked sever criticism from some economist that it only consider monetary phenomenon, ignoring other important factors of international trade in formatting balance of payment. Though, the MABP approach has  been much-admired for the implications of balance of payment. It is also criticized for neglecting errors transpire in balance of payment as well as responsible for disregarding to fiscal and real that manipulate changes in the balance of payments. Others are of the view that it does not ignore other factors but mainly concentrate that balance of payment should  be analyzed and observed from monetary theory. (Valinezhad, 1992) The main aim of this paper is to examine the monetary approach to the balance of
 payments (MABP), which argues that the balance of payments is a “monetary
 ph
enomenon”. Whereas the absorption and elasticity‟s
 approaches concentrate on the
 
 
 Department of Economics
3
Current account balance, the MABP emphasizes the overall balance of payments
 – 
 including the capital account (Coppin, 1994). By employing the MABP, the paper also intends to offer a basis for understanding the relationship between monetary policy and balance of payments problems in Pakistan. The research could also serve as a recommendation to monetary authorities in handling disequilibrium in the balance of payments.
Objective of the Study
The main objectives of the study are:
 
What are the factors and causes that bring disequilibrium in the balance of payment of Pakistan?
 
The monetary variables are responsible for creating disturbance of the balance of  payment.
 
Whether excess of money supply has played a significant role in the disequilibrium of balance of payments.
Organization of study
This paper is divided into five sections, one consist of the introduction while section two the literature review. The methodology is in section three.
 
The conclusion was taken care of in section four and finally the recommendations are in section 5.

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