The Australian balance of payments

This thesis looks at the major determinants of the Slze of the Australian balance of pa~nents. In particular the response of capital flows to monetary disequilibrium is examined in detail. We first reviewed the theory associated with the monetary approach to the balance of payments . This was a necessary frecursor to the later empirical work. Another forerunner to the empirical work was the construction of a simple model of the Australian economy. The approach to model specification was eclectic, incorporating theory from both traditional and monetary doctrine. This was nowhere more evident than in the balance of payments equations where traditional Keynesian demand theory was used to specify carrent account equations while monetarist notions were utilized in the specification for the capital account equations. The model consisted of 14 stochastic equations and 36 identities to model the real, financial, external and government sectors of the Australian economy. Nested within the model were two sets of financial portfolio equations. The theory of the behaviour of asset holders was reviewed and some new results on portfolio dynamics were developed. It was concluded that if portfolio holders minimize quadratic costs then the adjustment of asset levels must be stable and monotonic. The parameters of the model are estimated by the full information maximum likelihood method. The model was evaluated by simulation over the estimation period and into a prediction period. The dynamic multipliers associated with government policy variJbles were calculated. The consequences of a government induced increase in the Australian money supply was examined. It was shown that the initial increase in the money supply was offset by changes in other endogenous variables. The manner in which the initial increase was offset ln our model differed greatly from that suggested by previous studies of Australian capital flows. Although ln our model there was some offset through the capital account of the balance of payments there were also leakages through the current account, the amount of tax collected, the amount of nominal government expenditure and the money multiplier. In the experiment where the money supply was increased by a purchase of bonds by the authorities a major part of the adjustment to the increased money supply was carried out by changes in the money multiplier. The results obtained ln this thesis differed from other studies, which claimed that changes in the money supply were largely offset by capital account flows. It is claimed that other works lack sufficient model structure to provide a plau~ible explanation of capital flows in the Australian balance of payments