The Balance of Payments as a Monetary Phenomenon: Econometric Evidence from Pakistan

Abstract

This paper examines the monetary approach to Pakistan’s balance of payments for the period 1980-2008. Through the reserve flow equation, it tests whether excess money supply played a significant role as a disturbance by using Co- integration test and error-correction modeling. The empirical results showed that monetary variable does not play an overwhelming role in determining Pakistan’s balance of payments. The three significant relationships were found in between Gross Domestic Product Growth Rate (GDPG) and net foreign assets (NFA), which reflected a strong positive relationship, and between Domestic Credit (DOM_CREDIT) extension and net foreign assets, which reflected a strongly negative relationship, also between interest rate (INTEREST) and net foreign assets (NFA), which also reflected a strongly negative relationship as posited by the monetary approach to balance of payments. The results evidently showed that, although some variables suggested by the monetary approach play significant roles, the balance of payments is not a purely monetary phenomenon. Balance of payments disequilibrium can, therefore, not be corrected only through monetary actions by the authorities.