THE BALANCE OF PAYMENTS AND POLICY MIX: SIMULATIONS BASED ON A U.S. MODEL

Abstract

The model itself includes 53 stochastic equations and a dozen identities. The stochastic relationships were obtained with quarterly data spanning 1952-1969,2 using simple single-equation least-squares estimation. Specification was governed by three objectives: (1) to feature explicitly the principal instruments of fiscal and monetary policies-government expenditure, tax rates, and bank reserves; (2) to trace the important connections between domestic economic activity and the balance of payments, and to feed effects of changes in the balance of payments back into the domestic economy,3 (3) to facilitate simple, sequential programming. The foreign sector of the model is fairly large. It seeks to forecast separately each major component of the U.S. balance of payments.4 Furthermore, it offers and tests a number of hypotheses that have not found their way into other models. I argue, for example, that short-term variations in U.S. direct investment depend in chief on changes in monetary conditions affecting the locus and method of financing capital formation abroad, not on changes in the conditions affecting the long-term decision to undertake foreign investment. Finally, the model exploits my own earlier work on the determinants of short-term capital flows in the U.S. balance of payments.