Abstract
This research tested the monetary approach to Balance of Payment in developing countries of West Africa in order to affirm whether the specified relationship in the approach depicts correctly the actual behaviour of the economies. Time series and cross-sectional data that ranges from 1970 – 2016 were used. The empirical results of the fixed effect model established a significant positive relationship between net domestic credit, interest rate and exports; an insignificant positive relationship between capital movements, imports, income and the dependent variable. Exchange rate, however, had a significant negative relationship with the net foreign assets, while inflation had an insignificant but negative relationship with net foreign assets. The pairwise causality tests indicated a unidirectional relationship between exchange rate, net domestic credit and net foreign assets while the other variables move independently and cannot granger cause net foreign assets. Hence, the study concludes that the Polak model is valid in the West Africa Monetary Zone despite the fact that they are no more operating a fixed exchange rate system. The study suggests that the attention of the monetary authorities and the governments should not only be on decreasing the money supply in the economy, since an increase in net domestic credits has a positive impact on the net foreign assets provided it is channeled towards domestic production.
Highlights
It has been observed over time among developing countries that there is a prevalence of persistence current account deficit which is a major cause of concern because, maintaining a healthy and stable balance of payment and promoting trade drives rapid economic growth
The results indicated that Likelihood Ratio (LR), Final Prediction Error (FPE), Akaike Information Criterion (AIC), Schwarz Criterion (SC) and Hannan-Quinn Criterion (HQ) predicted 3, 3, 3, 1, and 3, lag respectively
It was discovered that a direct linear relationship exist between net foreign asset and net foreign asset at lag one [Net Foreign Assets (NFA) (-1)], income (INC), interest rate (INTR), exchange rate (EXCH) and MCIP while, an inverse relationship was observed between the net foreign asset (NFA) and export (EXPT), net domestic credit (NDC), (CM), inflation rate (INF) of the countries during the period under study
Summary
It has been observed over time among developing countries that there is a prevalence of persistence current account deficit which is a major cause of concern because, maintaining a healthy and stable balance of payment and promoting trade drives rapid economic growth. Stephen and Njuyuna (2000) applied the old Polak model to Kenya, pointing out that the behavioural equation of the Polak model ignores the other determinants of money balances like interest rate, inflation and wealth It assumed that changes in domestic credit have no effect on the determinants of money demand. Adamu and Itsede (2010), in their study of monetary approach to BOP in West Africa monetary zone, filled the above gap by including other determinants of money demand like inflation and interest rate but ignored the effect of exchange rate volatility on BOP as a control variable that the monetary authority should focus on, in addition to the net domestic credit (Polak 1997) Once an exchange rate is flexible, it becomes endogenous (Khan, 2008). Adamu and Itsede (2010), in their study of monetary approach to BOP in West Africa monetary zone, filled the above gap by including other determinants of money demand like inflation and interest rate but ignored the effect of exchange rate volatility on BOP as a control variable that the monetary authority should focus on, in addition to the net domestic credit (Polak 1997)
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