The Balance of Payments Adjustment Mechanism in a Rational Expectations Equilibrium
This paper provides a choice theoretic, general equilibrium
account of the balance of payments adjustment process and the determination
of national price levels in a world comprised of countries populated by
rational households. Balance of payments adjustment dynaniics arise in the
equilibrium of this model from the precautionary saving behavior of risk-
averse households who self-insure against random productivity fluctuations
by accumulating, via balance of payments surpluses in productive
periods, buffer stocks of domestic money which can be drawn down to finance
payments deficits, and thus a less variable profile of consumption relative to output, when productivity is unexpectedly low. Precautionary saving is shown to exhibit the
partial-adjustment-to-target behavior typically postulated in the monetary approach literature. The existence of a rational expectations equilibrium in which the distribution of international reserves among central banks is stationary is established.