Abstract
The monetary approach to the balance of payments has, in essence, two theorems: (i) The foreign assets of the central bank are negatively related to its domestic assets; (ii) the excess supply of money causes, and is equivalent to, the trade deficit. This paper tests these theorems for India using OLS, 2SLS, and co-integration, error-correction modelling. The IMF-supported adjustment programs are based upon the monetary approach to the balance of payments. It is shown that the first theorem may be refuted in a framework of general equilibrium with Keynesian features. Hence, it is concluded that the model of the economy should be estimated first in order to derive action parameters and performance criteria for stabilizing the economy.
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