A Monetary Approach to the Balance of Trade

Abstract

The predominant approach to empirical analyses of the balance of trade has been to estimate demand equations for quantities of imports and of exports, employing as explanatory variables relative prices and real incomes. This approach, referred to as the elasticities approach, is most notably exemplified by the work of Hendrick Houthakker and Stephen Magee, although other examples can be found discussed in the survey of such work by Magee (1975). In contrast, contemporary work falling under the rubric of the monetary approach to the balance of payments has emphasized that the balance of payments is determined by the net excess supply or demand for money. But because the balance of payments is identically the sum of the balance of trade, the capital account, and the service account, the monetary approach additionally implies that these subaccounts must be influenced in some way by the net excess supply or demand for money. The empirical work of Pentti Kouri and Michael Porter and of Kouri could be interpreted as combining in one model elements of both the elasticities approach to the balance of trade and the monetary approach to the balance of payments. In these studies, the current account (the sum of the balance of trade and service account) is assumed to be exogenous to the model while the behavior of the capital account is determined by the net excess supply or demand for money. In such a framework the balance of trade could be viewed as being determined by relative prices and real incomes, and the capital account could be viewed as that component of the balance of payments which is