BALANCE OF PAYMENT DETERMINATION: THE MONETARY APPROACH

TABLE OF CONTENTS

TITLE PAGE

CERTIFICATION

DEDICATION

ACKOWLEDGEMENT

TABLE OF CONTENTS

 

CHAPTER ONE

HISTORICAL BACKGROUND OF THE INTRODUCTION

1.1     Historical Background Of The. Study

1.2     Introduction

1.3     Statement of the problem

1.4     Research objectives

1.5     Research questions

1.6     Research hypothesis

1.7     Model specification

1.8     Significance of the study

1.9     Scope/Limitation of study

1.10   Method of data collection

1.11   Literature review

1.12   Organisation of the study

1.13   Contribution to knowledge

 

CHAPTER TWO

LITERATURE REVIEW

2.1     Literature review

2.2     Historical background of the study

2.3.    Definition and concepts of monetary approach

2.3.1 Balance of payments

2.3.2 Balance of payments adjustment under fixed exchanged

rates regime

2.3.3 Balance of payments adjustment under free floating exchange

rate regime

2.4     The control of the stock of money

2.5     Review of existing empirical evidence on the monetary approach

2.5.1 Evidence from industrial economics

2 .5.2 Evidence from developing economics

CHAPTER THREE

RESEARCH METHODOLOGY AND METHOD OF DATA COLLECTION

3.1     Research design

3.2     Research sample

3.3     Research instrument

3.4     Research techniques  

CHAPTER FOUR

DATA ANALYSIS AND INTERPRETATION OF RESULTS

4.1     Method of data analysis

4.2     Data analysis and Interpretation

CHAPTER FIVE

5.0     Summary, conclusion and recommendations

5.1     Summary

5.2     Recommendations

5.3     Conclusion

References

 

CHAPTER ONE

 

1.1.    HISTORICAL BACKGROUND OF THE STUDY

The monetary approach to balance of payments (MABP) has been a dominant view in the International Monetary Economics, particularly; the theory is believed to' have a long historical background. Which can be traced back to the writings of the classical economists who conceived a system of integrated world capital market and mobility? It is linked to the origin of balance of payments theory in the work of David Hume, and more specifically, to this theory of price-specie-flow mechanism (Johnson, 1976). While criticizing the objective of mercantilism in accumulating precious metals, David Hume pointed out that the amount of money in a country would be adjusted automatically to the demand for it. In Hume's analysis, the process in which this adjustment takes place is through surpluses and adjustment deficits in the balance of payments brought about by changes in relative national money price levels. However, while drawing heavily from Humes theory of balance of payments, and this analysis of price-specie­ flow mechanism, the monetary approach places emphasis' on monetary considerations in the interpretation of external balance problems rather than on changes in relative national price levels (Dornhusch and Fischer, 1990, 764).

 

The balance of payments account in Nigeria since political independence has undergone periods of boom and doom at different stages. The period of boom has been short-lived and is essentially attributed to the unprecedented increase in the oil price of 1973 - 1974. Apart from this period, Nigeria has continued to experience serious problems In the balance of payments position and the problem became severe in the early 1980' s. From an overall surplus of about N2A billion in 1980 in Nigeria's balance of payments, the country recorded a persistent deficits of (N3 billion), (Nl.4billion) and (0.3billion) in 1981, 1982 and 1983 respectively.

 

The internal factors that are responsible for the adverse balance of payments position in Nigeria include among other things, excessive demand for foreign products, heavy reliance base, political instability and structural rigidities in the domestic production process. The weaknesses, in the domestic macroeconomic policies have tended to the problem. Moreover, the trade and exchange rate policies pursued during the oil boom era of 1970s and early 1980s failed to generate the required incentives for earning or saving foreign exchange. Rather, they resulted in several macroeconomic distortions and entrenched import-oriented consumption and production patterns in Nigeria which widened the trade gap.

 

With respect to the monetary approach to balance of payment under a fixed exchange rate regime, this studies focused on the influence of changes or growth in determination of money demand as well as domestic component of money supply in changes or growth in external reserves.

 

The: results of these studies in most cases support the propositions of the monetary approach. For instance, Courechence and Youssefs (1967) study of the relative influence of imports and money supply on the demand foreign exchange reserves for a group of nine countries(Switzerland, Netherlands, Denmark, Sweden, Germany, Belgium, Italy, Japan and Australia) indicates that money supply is superior to the level of imports in determining the level of foreign reserves. Their empirical 'results indicate that money supply and long-term interest rate are arguments in the demand function for individual country's foreign exchanges reserves. From their study, Courchence and Youssef conclude that "the application of the concepts of monetary theory to the field of international payments can be very fruitful.

The basic concepts of the monetary approach can be found in the works of Frenkel and Johnson (1976), Musa (1974, 1976), Johnson (1958, 1972, 1976a, 1976b and 1977). Copppock (1978), Melvin (1984) and Uddin (1985). Other contributions to the development of the monetary approach to balance of payments (MABP) theory include. Mundell (1968), Dornbusch (1971), Tsiang (1977) and Bilson (1978). The central argument of the MABP is that external balance problems are essentially (but not exclusively) Monetary in nature. As such, the proponents of the monetary approach argue that the:

"Balance of payments problems in a monetary world should

be analysed by models that explicitly specify monetary behaviour

and integrate it with the real economy rather than by models

that concentrate on real relationships and real monetary behaviour as a residuance of real behaviour".

 

1.2     INTRODUCTION

Monetary approach exerts its influence on the economy through changes in money supply and interest rates. These variables also tend. to effect the position of the balance of payments at any point in time. Monetary approach deals only with the ultimate effect and not with the channels through which this effect occurs. Thus monetary approach is essential for sensible discussion of the balance of payments and that the money demand function and money supply process should play a central role in the balance of payments analysis, particularly for the long-run.

 

The monetary approach to the balance of payments dates back to David Hume's refutation by use of the analysis of the price-specie-flow mechanism of the mercantilist belief that a country could achieve a persistent external surplus by import-substitution and export promotion approach.

The reveal of the monetary approach was brought about through the growing reluctance of countries to resort to either-devaluation or appreciation of their domestic currencies to current external imbalance, together with the imposition of restraints on the ability of countries to use exchange controls and trade interventions respectively through the restoration of European currency convertibility in 1958 and successive common markets among 'countries. The restoration of the monetary-theoretic aspects of the balance of payments and included in the work of Hahn (1959), Kemp (1970) and Khan and Argy (1971).

 

With the continuous application of monetary approach in Nigeria coupled with the other economic policies aimed at solving the imbalance in the international trading and payments position, Nigeria has not been able to achieve viability and precision in its external reserve position. Among these studies are Gray (1963) which examined the effects of credit creation for investment purposes on the balance of payment for Nigeria's first- National Development Plan Period, Olofin et al 1986 which examined the effects of devaluation on the macro economy, Omobitan (1995), which concentrated on the study of the trends, issues and determinants of the balance of payments.

 

1.3     STATEMENT OF THE PROBLEM

'The monetary approach to the balance of payments has been related to the asset market 'approach. This analysis changes in the balance of payments position in terms of stock adjustments in the money market in which the supply and demand for money balances are eventually willingly held.

 

Since the global economic crisis of the 1980s, many developing countries like Nigeria has been grappling with numerous economic problems. Such problems include growing unemployment, unsustainable fiscal deficits, high inflationary pressures, mounting debt burden, adverse balance of payments, under-utilization of capacity and exchange rate misalignment. In Nigeria, the adverse balance of payments which could be attributed to a number of factor (both internal and external), reflect the deep-seated problems in the economy.

 

Amount the external factors contributing to the deterioration in the Nigeria's balance of payments are the economic recession experimented by most industrialized countries following the oil price shocks of 1973/74 and 1972/80. The rapid increase in the price of crude oil during this period made these industrialized countries adopt various energy conserving policies as well as restrictive monetary and fiscal policy measures which all the culminated the global economic recession and consequently- resulted in the collapse of the world oil market in the early I 980s. Other external factors include-the decline in capital flows, deterioration in Nigeria's terms of trade and rising (but floating) rate. interests in international capital and money markets, all of which worsened the country's external debt burden,.

 

These internal and external factors are however not mutually exclusive. They are in most cases, interrelated and tend to reinforce one another. Most often, policies needed to maintain external balance conflict within the required to restore internal balance, thereby making the problem intractable. The huge external debt burden and the dwindling foreign exchange reserves confronting most development countries tend to constrain their efforts to respond adequately to balance of payment shocks.

 

The empirical test of the monetary approach to the balance of payment analysis on the Nigerian economy which is the subject matter of this study shall provide precise solution to the problem outline above.

 

1.4     RESEARCH OBJECTIVES

The broad objectives of this study is to examine the relevance and applicability of the monetary approach to balance of payments in Nigeria, with a view of determining the extent to which the approach can serve as a useful framework for analyzing the balance of payments problems in the country.

 

The specific objectives of this study are:

1.       To test the propositions of the monetary approach to payments by way of analyzing the data from Nigeria.

2.       To examine the impact of economic growth on the balance of payments' position in Nigeria.

3.       Determine the nature and stability of money demand function, and the relevance of other basic assumptions of the monetary approach to balance of payments determination in the Nigerian context.

 

1.5     RESEARCH QUESTIONS

I.       Does monetary policy affect balance of payments in Nigeria?

2.       What impact does economic growth has on the balance of payments'   position in Nigeria?

3.       The determination of the nature and stability of money demand function have no effect on the balance of payments determination in the Nigerian context.

 

1.6.    RESEARCH· HYPOTHESIS

Ho:    That monetary policy does not affect balance of payments in Nigeria

Ha:    That monetary policy affects balance of payments in Nigeria

Ho:    That economic growth does not have any impact on the balance of payments' position in Nigeria.

Ha:    That economic growth has impact on the balance of payments' position in Nigeria

Ho:    The determination of the nature and stability of money demand function have no effect on the balance of payments determination in the Nigerian context.

Ha:    The determination of the nature and stability of money demand function have a great effect on the balance of payments determination in the Nigerian context.

 

1.7     MODEL SPECIFICATION

GDP = F (ms, md, bop) under the hypothesis that

Ho = Bo = B1= B2=B3= 0

Ha Bo≠B1 B2≠B3≠0

From the above, the null hypothesis (Ho) states' that the values of the estimated parameters are not significantly different from zero, while the alternative hypothesis (Ha) states that the values of the estimated parameters are significantly not equal to zero, which is our theoretical expectation.

 

ECONOMETRIC MODELSPECIFATION

This study will use a multi-regression analysis to investigate that:

GDP = Bo + B1MS + B2 BOP + B3MD + U

This win be regressed following a list wise regression in the following ways

MODEL 1

GDP=Bo+B1MS+U

Where GDP = Growth of the Gross Domestic Product

Bo = intercept or constant term of the relationship

Bl= coefficient of MS

The model is to test the single impact of rate of growth of money supply on Gross Domestic Product

Hypothesis of the Model

Ho     =       That monetary policy does not affect balance of payments in Nigeria

Ha      =        That monetary policy affects balance of payments in Nigeria

MODEL2

GDP =Bo + B1MS + B2 BOP + U

Where B2    =       Coefficient of BOP

The model is to test the impact of money supply and balance of payments Gross Domestic Product

 

Hypothesis of the model

Ho     =       That economic growth does not have any impact on the balance of      payment in Nigeria.

Ha     =       That economic growth have impact on the balance of payments' position in Nigeria.

MODEL 3

GDP= Bo+BlMS+B2BOP+B3MD+U

Where B3 = coefficient of Md

The model is an improved fashion of (1 and 2) as it now involves money demand and money supply.

Hypothesis of the model

Ho     =       The determination of the nature and stability of money demand function have no effect on the balance of payments determination in the Nigerian context.

Ha     =       The determination of the nature and stability of money demand function have a great effect on the balance of payments determination in the Nigerian context.

 

1.8.    SIGNIFICANCE OF THE STUDY

The need for this study arises from the inability of the Nigerian economy at experiencing a favourable balance of payment position for most parts of the period since independence. Fundamental surpluses are only recorded in 1974· and 1990 in Nigeria 's balance of payments when N3, 102.2 billion and N 18? 498.2 million overall balances are recorded respectively. For most of the other periods, surpluses have been insignificant and for only few periods, deficits have been the order.

 

The structural adjustment programmes embarked upon by most developing countries including Nigeria, since the 1980s device their basic analytical framework largely from the financial programming model of the International Monetary Fund (IMF).Though the adjustment programmes are complex package of policy measures aimed at a number of objectives including the attainment of a viable balance of payments, satisfactory long­-term growth performance and low inflation (Khan, 1990: 95) the immediate objective of the IMF's financial programming model is the attainment of a viable balance of payment position. According to Khar, Monthel and Haque (1986), the model is essentially a monetary model, built on the framework that links the financial sector with the balance of payments.

 

From the foregoing, it is evident that the theoretical basis of the -IMF's approach to economic stabilization and adjustment is the monetary approach to balance of payments which views external imbalance as emanating essentially from monetary disequilibrium. This has accounted for the extensive use of the monetary approach in analyzing, and designing economic policies for countries in balance of payments trouble (Dornbusch and Fischer, 1990. 764). Thus, the need to examine the theoretical basis and empirical relevance of the monetary approach to balance of payments determination in the Nigerian context cannot be disputed at this period of economic reform, programme in the proponents of the monetary approach suggest that the effectiveness of various policy reform measure in the place to address the balance of payments problems in the economy would depend mainly on how their monetary implications are taken into consideration and on the ability of the monetary authorities to control money supply and credit creation.

 

1.9     SCOPEANDLIMITATIONOFTHESTUDY

The study covers two distinct periods of exchange rate arrangement in post independence Nigeria. The first period (1960 - 198$) covers the regime of -relatively fixed exchange rates, while. the second period (1986 -1997) covers the regime of floating exchange rate. The influence of the, determinants of money supply and money demand on the balance of payments (as measured by external reserve flows) is examined in the first period, while the influence of' the determinants of money supply and money demand on exchange rate changes is examined in the second period.

 

Annual data are used for the first period, while quarterly data are employed in the second period because of the short period of flexible 'exchange rate system in Nigeria (i.e, between 1986 - 1997).

 

The major constraints of this study are the inaccurate data; the cost and time requires carrying out this research.

 

1.10   METHOD OF DATA COLLECTION

This study will make use of econometrics modeling coupled with an indepth descriptive analysis of the relevant macro-economic . variables that have direct or indirect. The necessary diagnostic 'and significant test will be conducted on the estimated equations.

This study will make use of secondary data and the main source of these data will be from:

  1. The International Financial Statistics Year Book of the International

Monetary Fund (IMF) for several years.

  1. Annual Reports and Statement of Accounts for Central Bank of Nigeria

between 1960 and 1994.

  1. The CBN Economic and Financial Review for the periods 1970-1994.
  2. The CBN Statistical Bulletin-December 1994.

 

1.11. LITERATURE REVIEW

The monetary approach to balance of payments could be regarded as an extension of the rudiments of monetary theory to the area of the balance of payments. Three-main factors could be attributed to the renewed interest in the approach in the post-world war II. The first factor was the re-birth of academic interest in monetary problems as spearch headed by Milton Friedman and others from the University of Chicago. The second factors emanated from the search by the International Monetary Fund (IMF) for a monetary framework within which the balance of payments policies could be evaluated.

 

The monetary approach to balance of payments (MABP) has been a dominant view in. the International Monetary Economics, particularly; the theory is believed to have a long historical background, Which can be traced back to the writings of the classical economists who conceived a system of integrated world capital market and mobility? It is linked to the origin of balance of payments theory in the work of David Hume, and more specifically, to this theory of price-specie-flow mechanism (Johnson, 1976). While criticizing the objective of mercantilism in accumulating precious metals, David Hume pointed out that the amount of money in a country would be adjusted automatically to the demand for it. In Hume's analysis, the process in which this adjustment takes place is through surpluses and adjustment deficits in the balance of payments brought about by changes in relative national money price levels. However, while drawing heavily from Hume's theory of balance of payments, and this analysis of price-specie-flow mechanism, the monetary approach places emphasis on monetary considerations in the' interpretation of external balance problems rather than on changes in relative national price levels (Dromhusch and Fischer, 1990, 764).

 

The difficulties in applying the conventional elasticity/absorption approaches to external balance on the developing economies prompted the search. Thirdly, it was then the view that the monetary approach might provide a better 'framework within which the balance of payments policies could be easily applied and evaluated, given the reliance of majority of the developing economies on monetary policies which operated in conjuction with relatively to the financial markets.

 

1.12   ORGANISATION OF THE STUDY

In chapter one, we have presented a general introduction -of this study. Also, the objectives, scope of the study as well as the need for the study are also stated in this chapter.

 

In chapter two, relevant literatures will be reviewed. Specifically, literatures and empirical works directed at testing the monetary approach to the balance of payments will be reviewed. The theoretical framework governing the monetary theory of balance of payments analysis will be presented in chapter two as well. The operations of monetary policies under various exchange rate regimes will be discussed.

 

In chapter three of this study over view of balance of payment in Nigeria. This talk about the balance of payment related with Nigeria. The administration of monetary approach coupled with the study of the trends issues and factor affecting Nigeria's balance of payments will also be discussed in chapter three.

 

Chapter four will be centered on an empirical and descriptive analysis of relevant data. The basic feature and assumptions as well as some of the existing empirical finding on the monetary approach to balance of payments are reviewed, while the methodology, model specification and estimation techniques as well as data description.

 

Finally, in chapter five, we present a summary of findings of the study, on the basis of which some policy conclusions are drawn. The limitations of the study and areas for further study are also highlighted in this chapter.

 

1.13   CONTRIBUTION TO KNOWLEDGE

With respect to the monetary approach to balance. of payment under a fixed exchange rate regime, this .studies focused on the influence of changes or growth indetermination of money demand as well as domestic component of money supply in changes or growth in external reserves.

The results of these studies in most cases support the propositions of the monetary approach. For Instance, Courechence and Youssefs (1967) study of the relative influence of imports and money supply on the demand foreign exchange reserves for a group of nine countries (Switzerland, Netherlands, Denmark, Sweden, Germany; Belgium, Italy, Japan and Australia) indicates that 'money supply is superior to the level of imports in determining the level of foreign reserves. Their empirical results indicate that money supply and long-term interest rate are arguments in the demand function for individual country's foreign exchanges reserves. From their study, Courchence and Youssef conclude that "the application of the concepts of monetary theory to the field of international payments can be very fruitful.

Get the Complete Project