TWO VIEWS OF THE BALANCE OF PAYMENTS

In Chapter 12, we went through the balance-of-payments accounts from the top down. We started with trade in goods and services and investment-income flows, paused to calculate the current-account balance, and then went on to the capital account. The surplus or deficit in the balance of payments appeared at the end as the change in official reserves. It reflected official purchases or sales of foreign currency designed to keep the exchange rate from changing.

Therefore, we came to think of surpluses and deficits as measures of disequilibrium in the flow market for foreign exchange. More important, we saw that they reflect events in many other markets—foreign and domestic markets for goods, services, and assets. In subsequent chapters, we looked at ways of dealing with surpluses and deficits by policies affecting those events and markets. In Chapters 13 and 14, we studied ways of altering demands for goods and services—policies affecting incomes, prices, and exchange rates. In Chapters 15 and 16, we studied ways of altering demands for assets—policies affecting interest rates and exchange-rate expectations.

There is another way to look at the balance of payments. It is very old but has been revived and modernized. Instead of focusing on flows across the foreign-exchange market and the flows that lie behind them in markets for goods, services, and assets, it focuses directly on their monetary counterpart, the net change in the stock of domestic money resulting from a balance-of-payments surplus or deficit.