COWLES FOUNDATION FOR RESEARCH IN
ECONOMICS Box 208281
COWLES FOUNDATION DISCUSSION PAPER NO. 769 "The Balance of Payments Adjustment Mechanism Richard H. Clarida April 1985 This paper provides a choice theoretic, general equilibrium account of the balance of
payments adjustment process and the determination of national price levels in a world
comprised of countries populated by rational households. Balance of payments adjustment
dynamics arise in the equilibrium of this model from the precautionary saving behavior of
risk-averse households who self-insure against random productivity fluctuations by
accumulating, via balance of payments surpluses in productive periods, buffer stocks of
domestic money which can be drawn down to finance payments deficits, and thus a less
variable profile of consumption relative to output, when productivity is unexpectedly low.
Precautionary saving is shown to exhibit the partial-adjustment-to-target behavior
typically postulated in the monetary approach literature. The existence of a rational
expectations equilibrium in which the distribution of international reserves among central
banks is stationary is established. |
