CHAPTER 13
MECHANISMS OF INTERNATIONAL ADJUSTMENT
CHAPTER OVERVIEW
This chapter considers balance–of-payments adjustments under fixed exchange rates. Because persistent balance–
of-payments disequilibria tends to have adverse economic consequences, there exists a need for adjustment.
The chapter notes that balance-of–payments adjustment can be classified as automatic or discretionary. Under a
system of fixed exchange rates, automatic adjustments can occur through variations in prices, interest rates, and
incomes. The demand for and supply of money can also influence the adjustment process.
The foreign repercussion effect refers to a situation in which a change in one nation’s macroeconomic variables
relative to another nation’s will induce a chain reaction in both nations’ economies.
Finally, the chapter considers the monetary approach to the balance of payments as an alternative, rather than a
supplement, to traditional adjustment theories. It maintains that, over the long run, payments disequilibria are rooted
in the relationship between the demand for and the supply of money. Adjustment in the balance of payments is
viewed as an automatic process by the monetary approach.
After completing the chapter, students should be able to:
BRIEF ANSWERS TO STUDY QUESTIONS
1. Balance-of-payments adjustment concerns the return to payments equilibrium after the initial equilibrium has
been disrupted. Deficit countries face adjustment incentives due to limited quantities of international reserves
2. Automatic balance–of-payments adjustments consist of changes in domestic prices, interest rates, and income.
The impact of money on the balance of payments is also considered an automatic adjustment mechanism.
3. The quantity theory of money is a theory based on the equation of exchange that hypothesizes that a change
in the money supply will cause a proportional change in the price level. Under the classical gold standard, a
5. The Keynesian income adjustment mechanism suggests that a nation with a payments surplus would
6. The foreign repercussion effect suggests that in a two-country world, a change in the level of trade of
7. A main problem of the automatic adjustment mechanisms is that a country must be willing to accept
domestic inflation or recession when current-account adjustments require it.