A Note on Monetary and Non-Monetary Analyses of LDCs Balance of Payments Problems

Iqbal Zaidi


Although balance of payments problems have been pervasive in
the developing economies, there is little agreement amongst economists
as to the causes and the cures for these problems. This paper focuses
upon two models of the balance of payments: the two-gap model and the
monetary approach to the balance of payments (MAEP). The two-gap model
describes the chronic excess demand for foreign exchange in the
developing economies as structural in origin, and implies that monetary
cures for it do not seem to be relevant. MAEP, on the other hand,
describes balance of payments deficits as reflecting disequilibrium in
the money market and hence must be treated as a monetary phenomenon,
requiring the use of tools and concepts of monetary theory. Balance of
payments disequilibrium involves an inflow or outflow of inter┬Čnational
money, and the behaviour of monetary authorities is regarded as crucial
to any sensible study of the balance of payments. The analysis of these
two models presented in this paper tries to reveal their underlying
structures and emphasizes the differences in their approach to the
balance of payments problems. After providing brief expositions of the
two models in the following two sections, we discuss the importance of
the assumptions in each of the model. Next, we present a synthesis by
relating to the two-gap model some aspects of the monetary approach.
This has not been done before in the literature. This attempt at a
synthesis raises certain issues, some of which are answered in this
paper. For instance, we are able to provide a reasonable explanation of
why the LDC governments engage in excessive credit creation, leading to
balance of payments deficits and then devaluation.

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DOI: https://doi.org/10.30541/v17i3pp.345-354


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