Improvement in the Balance of Payments: A Response to Monetary Policy or to Ad Hoc Fiscal Policies

THE events of the past few years have alerted economists and non-economists alike to the difficulty of choosing appropriate monetary policies while making the implicit assumption that the economy is closed. The problems posed for policy-makers by the existence of a deficit in the balance of payments and a continued gold outflow are familiar enough. Indeed, the balance-of-payments deficit and the gold outflow have received so much recent attention that it is perhaps time to recall that there are also dangers in ignoring or minimizing certain domestic effects of monetary policy. The dangers result from the tendency to equate monetary policy with its effect upon interest rates and its effects on gold outflows and balance-of-payments deficits through interest rates.

My conclusion that the domestic effects of changes in money are often ignored is based on several sources. Some of these are familiar; for example, the analysis that was widely used to support the 1964 tax cut in the United States, and recent governmental policy statements suggesting that monetary policy be used for balance-of-payments purposes, while fiscal policy be used to stimulate the domestic economy. More disturbing are the indications of a possible change in current monetary policy that is reflected in a reduced growth rate of the money supply. Enticing as it is to speculate about the present direction of policy, it is probably more fruitful to discuss the rationale used to justify the policy actions of the last few years.