Instructor’s Manual
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
After completing the chapter, students should be able to:
• Identify the adverse effects that persistent balance–of-payments disequilibriums have on an economy.
• Discuss the automatic adjustment mechanisms in the balance of payments that occur under a system of fixed
exchange rates.
Instructor’s Manual
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
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
4. Changes in interest rates promote balance-of-payments adjustments via their impact on short-term capital
movements.
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