An empirical test of the monetary theory of the balance of payments : India, 1950 to 1965

The purpose of this study was to examine the theoretical and empirical aspects of the monetary theory of the balance of payments. The empirical part of the study is concerned with the balance of payments of India for the period of 1950 to 1965. The initial discussion of Chapter 1 deals with the doctrinal evolution of the monetary theory of the balance of payments. In the discussion of the doctrinal development of the theory, an endeavor has been made to show that the origin of the monetary theory of the balance of payments antedates the contribution of David Hume. After this, the theoretical and empirical aspects of the traditional approach (a combination of elasticities-absorption) to the balance of payments is discussed. In this respect, the criticism leveled at the Meadean synthesis by Kuska has been briefly reviewed. The promulgators of the monetary approach aver that the balance of payments is essentially determined by the monetary forces, and the elasticities-factor stressed by the traditional approach as a determinant of the balance of payments is insignificant.

An aggregated monetary model of the balance of payments along with the assumptions specified is discussed in Chapter 2. The real-balance effect plays the key role in the adjustment process. It is indicated that whenever actual money balances in peoples' possession exceed that desired, a deficit occurs in the balance of payments. Chapter 3 presents a critique of the monetary theory of the balance of payments. Empirical and theoretical criticism of the assumption of a stable demand for money function has been dealt with. It is shown that Keynes thought of the balance of payments as essentially a monetary phenomenon.

In Chapter 4, an empirical test is made of the monetary theory of the balance of payments in the case of India. The mathematical model deployed for the empirical investigation is more disaggregated than the one presented in Chapter 2. Because of this, it has been possible to compute the income elasticity of demand for money, the price elasticity of demand for money, the interest elasticity of demand for money, the value of the money multiplier, and the value of the domestic component of the monetary base. The results obtained from the regression analysis do not permit support of the theory under investigation. Subsequently, the factors have been analyzed that prevented the support of the monetary theory in India's case: the availability of foreign aid and free food imports, and the existence of extensive and comprehensive controls over domestic economic activity by the Indian government.