The monetary approach assumes that exchange rates are pegged, that the economy is in long-run full-employment equilibrium, that the demand for money is a stable function of income, that changes in the money supply do not affect real variables, that in the long run a country’s price level and interest rate converge on …

What do you mean by monetary approach?

The monetary approach to the balance of payments is an explanation of the overall balance of payments. It explains changes in balance of payments in terms of the demand for and supply of money.

What are the conditions of the balance of payment?

The sum of all transactions recorded in the balance of payments must be zero, as long as the capital account is defined broadly. The reason is that every credit appearing in the current account has a corresponding debit in the capital account, and vice-versa.

Does monetary policy affect balance of payments?

An expansionary monetary policy worsens the balance of payments. the real interest rate falls causing an outflow of capital, so the BOP worsens. real income rises, so imports go up and the BOP worsens. the price level rises causing imports to rise and exports to fall, so the BOP worsens.

What is the monetary approach to exchange rate?

The monetary approach happens to be one of the oldest approaches to determine the exchange rate. It is also use as a yardstick to compare the other approaches to determine exchange rate. The monetary model assumes a simple demand for money curve. The purchasing power parity or the law of one price holds true.

What’s the monetary approach to the exchange rate?

In summary, while the monetary approach regards exchange rates as relative prices of currencies which are determined by stock equilibrium in the currency markets, the traditional approaches consider that an exchange rate is determined by the flow (as opposed to stock) currency markets.

What is monetary approach to poverty?

The monetary approach to measuring poverty is the most commonly used. It uses calculations of household income (including own production and expenditures per capita) to identify a shortfall in consumption (or income) from a specified poverty line.

What is the concept of balance payment?

Balance Of Payment (BOP) is a statement which records all the monetary transactions made between residents of a country and the rest of the world during any given period.

What is the importance of balance of payment?

The importance of the balance of payment can be calculated from the following points: It examines the transaction of all the exports and imports of goods and services for a given period. It helps the government to analyse the potential of a particular industry export growth and formulate policy to support that growth.

How does monetary policy maintain balance of payment?

If monetary policy is responsive to the balance of payments, the lower channel would operate. A weak external sector will cause the authorities to implement a tight money policy, which in time will reduce income. (Thus, an increase in income in a previous period will lead to a decrease in income in the present period.)

Why is the monetary approach to the balance of payments criticised?

The monetary approach to the balance of payments has been criticised on a number of counts: 1. Demand for Money not Stable: Critics do not agree with the assumption of stable demand for money. The demand for money is stable in the long run but not in the short run when it shows less stability.

What are the assumptions of the monetarist approach?

Assumptions underlying the Monetarist Approach: The monetary approach is based on the following assumptions: The demand for money is a stable function of income, prices and interest rate. The supply of money is a multiple of monetary base which includes domestic credit and the country’s foreign exchange reserves.

What are the different approaches to balance of payments?

There are three basic alternative theories or approaches to the balance of payments adjustment namely, the elasticities approach, the absorptions approach, and the monetary approach. In the elasticities and absorption approaches the focus of attention is on the trade balance with resources not fully employed.

What is the mechanism of absorption approach to the balance of payments?

It is, therefore, also known as the Keynesian approach. It runs through the income effect of devaluation as against the price effect to the elasticity approach. The theory states that if a country has a deficit in its balance of payments, it means that people are ‘absorbing’ more than they produce.