The Determination of the Stock of Reserves and the Balance of Payments in a Neo-Keynesian Model: Comment

Abstract

Professor Neil Wallace has developed a neo-Keynesian model that determines the stock of reserves and balance of payments.l ffis analysis improves on other neo-Keynesian models by distinguishing between once-and-for-all portfolio adjustments and continuing capital flows. Although Wallace's approach is quite interesting, detailed examination of his model reveals several flaws that weaken the analysis. In the portfolio adjustment part of the basic model he fails to distinguish between money and real rates of interest, to recognize that the change in the desired stock of domestic assets held by foreigners due to a rise in the domestic interest rate is not normally the foreign demand for additional domestic assets, and to consider domestic portfolio equilibrium. In his analysis of capital flows, he fails to deduct interest payments to foreigners from domestic income. Part II comments on the impact of the flaws in the portfolio adjustment version of the basic model, and Part III comments on the flow version.