• TABLE OF CONTENTS
HIDE
 Title Page
 Acknowledgement
 Table of Contents
 List of Tables
 Abstract
 Introduction
 The role of money in the process...
 Monetary arrangements in Guyan...
 An empirical investigation of the...
 Economic growth, domestic financial...
 Summary of study
 Conclusions
 Appendix
 References
 Biographical sketch














Title: Economic instability and the monetary process of adjustment in an open economy
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 Material Information
Title: Economic instability and the monetary process of adjustment in an open economy the experience of Guyana: 1955-1973
Physical Description: vii, 106 leaves : ill. ; 28 cm.
Language: English
Creator: Modeste, Nelson C., 1951-
Publication Date: 1976
Copyright Date: 1976
 Subjects
Subject: Monetary policy -- Guyana   ( lcsh )
Economic conditions -- Guyana -- 1918-   ( lcsh )
Economics thesis Ph. D
Dissertations, Academic -- Economics -- UF
Genre: bibliography   ( marcgt )
non-fiction   ( marcgt )
 Notes
Thesis: Thesis--University of Florida.
Bibliography: Bibliography: leaves 102-105.
Additional Physical Form: Also available on World Wide Web
General Note: Typescript.
General Note: Vita.
Statement of Responsibility: by Nelson C. Modeste.
 Record Information
Bibliographic ID: UF00097510
Volume ID: VID00001
Source Institution: University of Florida
Holding Location: University of Florida
Rights Management: All rights reserved by the source institution and holding location.
Resource Identifier: alephbibnum - 000177159
oclc - 03085224
notis - AAU3651

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Table of Contents
    Title Page
        Page i
        Page i-a
    Acknowledgement
        Page ii
    Table of Contents
        Page iii
    List of Tables
        Page iv
    Abstract
        Page v
        Page vi
        Page vii
    Introduction
        Page 1
        Page 2
        Page 3
        Page 4
        Page 5
        Page 6
        Page 7
    The role of money in the process of international adjustment
        Page 8
        Page 9
        Page 10
        Page 11
        Page 12
        Page 13
        Page 14
        Page 15
        Page 16
        Page 17
        Page 18
        Page 19
        Page 20
        Page 21
        Page 22
    Monetary arrangements in Guyana
        Page 23
        Page 24
        Page 25
        Page 26
        Page 27
        Page 28
        Page 29
    An empirical investigation of the process of adjustment according to the quantity theory of money
        Page 30
        Page 31
        Page 32
        Page 33
        Page 34
        Page 35
        Page 36
        Page 37
        Page 38
        Page 39
        Page 40
        Page 41
        Page 42
        Page 43
        Page 44
        Page 45
        Page 46
        Page 47
        Page 48
        Page 49
        Page 50
        Page 51
        Page 52
        Page 53
        Page 54
        Page 55
        Page 56
        Page 57
    Economic growth, domestic financial policies and the balance of payments
        Page 58
        Page 59
        Page 60
        Page 61
        Page 62
        Page 63
        Page 64
        Page 65
        Page 66
        Page 67
        Page 68
        Page 69
    Summary of study
        Page 70
        Page 71
        Page 72
        Page 73
        Page 74
        Page 75
        Page 76
        Page 77
        Page 78
        Page 79
        Page 80
        Page 81
        Page 82
        Page 83
        Page 84
        Page 85
        Page 86
        Page 87
        Page 88
        Page 89
        Page 90
        Page 91
    Conclusions
        Page 92
        Page 93
        Page 94
        Page 95
    Appendix
        Page 96
        Page 97
        Page 98
        Page 99
        Page 100
        Page 101
    References
        Page 102
        Page 103
        Page 104
        Page 105
    Biographical sketch
        Page 106
        Page 107
        Page 108
Full Text












ECONOMIC INSTABILITY AND THE MONETARY
PROCESS OF ADJUSTMENT IN AN OPEN ECONOMY:
THE EXPERIENCE OF GUYANA: 1955-1973.

















By

NELSON C. MODESTE


A DISSERTATION PRESENTED TO THE GRADUATE COUNCIL
OF THE UNIVERSITY OF FLORIDA
IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE
DEGREE OF DOCTOR OF PHILOSOPHY




UNIVERSITY OF FLORIDA


1976

















































UNIVERSITY OF FLORIDA


3 1262 08666 405 8














ACKNOWLEDGEMENTS


The author is most grateful to Dr. Michael Connolly,

Chairman of his Supervisory Committee, for his generous

and learned assistance. Special thanks are also extended

to the other members of his committee; Dr. William Tyler,

Dr. Robert Emerson, Dr. G. S. Maddala, and Dr. Philip

Friedman. His deepest affection and appreication goes to his

mother, Mrs. Ethel Mlodeste and typist, Ms. Yvonne Robertson.















CONTENTS

ACKNOWLEDGEMENTS .............................

LIST OF TABLES .................................

ABSTRACT......................................

CHAPTER I ....................................

INTRODUCTION .............................

CHAPTER II ...................................

THE ROLE OF MONEY IN THE PROCESS OF
INTERNATIONAL ADJUSTMENT ................

No tes ................................

CHAPTER III ..................................

MONETARY ARRANGEMENTS TN GUYANJA..........

CHAPTER IV ..................................

AN EMPIRICAL INVESTIGATION OF THE PROCESS


OF ADJUSTMENT ACCORDING TO THE


QUANTITY


THEORY OF MONEY. ........................


Notes........

CHAPTER V ............

ECONOMIC GROWTH,
POLICIES AND THE

CHAPTER VI ...........

SUMMhARY OF STUDY.

CHAPTER VII ..........

CONCLUSIONS ......

APPENDIX..............

REFERENCES............

BIOGRAPHICAL SKETCH..


DOMESTIC
BALANCE



















iii
Ill


...........

...........

FINANCIAL
OF PAYMENTS

...........

...........

...........

...........

...........

...........

...........


PAGE

ii


iv

V

1


1

8


30

57

58



58

70


70

92

92


96

102

106















LIST OF TABLES


TABLE III-1


TABLE IV-1



TABLE IV-2


TABLE IV-3



TABLE IV-4



TABLE IV-5


TABLE V-1


TABLE VI-1



TABLE VI-2


TABLE VI-3



TABLE VI-4


GUY'ANA'S MONEY SUPPLY, NET FOREIGN
ASSETS AND DOMESTIC ASSETS............

CALCULATED INDICIES OF INSTABILITY
IIN EXPORT EARNINGS FOR THE LESS
DEVELOPED COUNTRIES ...................

CAUSES OF INSTABILITY IN EXPORT
EARNINfGS ..............................

INSTABILITY INDICIES FOP QUANTITY,
UNIT VALUE AND TOTAL VALUE OF GUYANA'S
MAJOR EXPORT COMMODITIES: 1956-73.....

ESTIMATES FOR THE CHANGES IN IMPORT
EQUATION AND THE INSTABILITY IN
DOMESTIC INVESTMENT EQUATION..........

ESTIMATES FOR THE BALANCE OF
PAYMENTS EQUATION ......................

ESTIMATES FOR THE MONETARY APPROACH
TO THE BALANCE OF PAYMENTS ............

ESTIMATES OF THE MONETARY PROCESS OF
ADJUSTMENT ACCORDING TO THE QUANTITY
THEORY OF MONEY .......................

INSTABILITY IN EXPORTS, INCOME AND
INVESTMENT ............................

INSTABILITY INDICIES FOP QUANTITY, UNIT
VALUE AND TOTAL VALUE OF GUYANA'S
MAJOR EXPORT COMMODITIES: 1956-1973....

ESTIMATES FOR THE VARIOUS NOTION
ASSOICATED WITH THE MONETARY APPROACH
TO BALANCE OF PAYMENTS THEORY..........


PAGE













Abstract of Dissertation Presented to the
Graduate Council of the University of Florida
in Partial Fulfillment of the Requirements for the
Degree of Doctor of Philosophy



ECONOMIC INSTABILITY AND THE MONETARY
PROCESS OF ADJUSTMENT IN AN OPEN ECONOMY:
THE EXPERIENCE OF GUYANA: 1955-1973

by

Nelson C. Modeste

December, 1976

Chairman: M. B. Connolly
Major Department: Economics

This study examines, on the basis of the economic

experience of Guyana between 1955-1973, the monetary process

of adjustment in an open economy. Two monetary models are

used for analyzing the process of adjustment. The first

serves as the basis for analyzing the effects of an increase

in exports and net capital inflow. on income, the balance of

payments, the money supply, and imports. It also serves to

analyze the problem of instability in export earnings. The

analysis suggests that the excessive degree of fluctuations

in Guyana's export earnings upsets equilibrium in the balance

of payments which consequently generates through the process

of adjustment instability in domestic economic activity.

The second model looks at the process of adjustment from the

standpoint of the new monetary approach to balance of payments

theory. This model permits us to examine such issues as





the effects of economic growth and credit financing of the

government's budget deficit on Guyana's balance of payments.

It also permits us to examine the degree of correspondence be-

tween the domestic rate of inflation and the rate of inflation

in the world.

The findings as far as the operation of the process of

adjustment in Guyana is concerned, indicate that the internal

process of adjustment to a surplus or deficit in the balance

of payments is generally very quick. In particular the re-

sults indicate that within the first year there is almost con-

plete adjustment between changes in imports and changes in

the sum of exports and net capital inflow. The results also

indicate that the expansion of bank credit is responsible for

most of the changes in Guyana's holdings of net foreign assets.

The analysis of the causes and effects of instability in

Guyana's export earnings indicate that the instability in the

country's export earnings produce a similar degree of in-

stability in the country's level of money income. The data

however fail to substantiate the thesis that the instability

in export earnings causes instability in domestic investment

and that the causes of the wide swings in Guyana's export

earnings lie in the high ratio of primary products exported

and the high degree of product and geographic concentration.

The results from the second model again substantiate

the earlier result that the expansion of bank credit is re-

sponsible for most of the changes in the country's holdings of

foreign assets. It furthermore indicates that the credit

financing of the government's budget deficit also generate





economic forces which ultimately result in the outflow of

foreign assets. The empirical results, rather disappointingly,

failed to produce a statistically significant coefficient for

the effects of growth in real income on the flow of reserves.

In general these results indicate that the process of

adjustment operates very quickly in Guyana and that there is

a need for controlling the rate of expansion of bank credit.


vi i










CHAPTER I

I INTRODUCTION



In most developing countries international trade con-

trols, via the balance of payments, the process of income

and money creation. This relationship between income,

money creation and the balance of payments has however created

two problems. The first is that of instability in domestic

economic activity. This problem arises from the process of

adjustment which occurs within the economy in response to

the state of disequilibrium in the balance of payments

(Levin, 1960, pp. 10-12; Wallich, 1950, p. 302). For example

an increase (decrease) in export earnings can generate a

surplus (deficit) in the balance of payments and because of

the linkage of the money supply to the balance of payments

it will cause an expansion (contraction) in the money supply

which will thereby generate expansionary contractionaryy)

effects on domestic economic activity. Consequently, it is

concluded that the increases (decreases) in export earnings

not only increases (decreases) income and the money supply,

but that in addition it causes instability or fluctuations

in domestic economic activity.

The second problem concerns the relationship between

the balance of payments and economic growth. A very popular

view emanating, until quite recently, from the literature and






other standard text-books in economics, was that as economic

growth occurs the increase in income will subsequently in-

crease the demand for imports relative to exports and that

there would consequently develop balance of payments difficul-

ties which would require the adoption of measures to either

restrict trade and/or reduce economic growth (Dernburg and

MacDougall,1972, p. 268; Johnson, 1954; Kindleberger, 1973. p.

349; Meier, 1968, pp. 73-75). This proposition has recently

been subject to some severe criticisms (Johnson, 1972; Komiya,

1969), particularly since it omits from consideration the

effects of the increase in income on the demand for money and

the subsequent effects on domestic expenditures.

The purpose of this study will be to examine for Guyana,

a small open economy, the following issues:

1. The effects of an increase in exports and net
capital inflows on (a) the balance of payments,
(b) on the money supply, (c) on imports, and
(d) on money income. It will also examine the
causes of the excessive changes in export
earnings, and determine whether as a result of
the adjustment mechanism, the fluctuations in
export earnings cause similar fluctuations in
money income.

2. The effects of an increase in real income and
domestic financial policies on the balance of
payments.

In a study on the effectiveness of monetary policy in

Netherlands, Holptrop (1972) empirically examines part of the

process of adjustment which an open economy experiences when

there is disequilibrium in the monetary sector. Specifically

Holtrop looks at the effects of changes in domestic assets,

and changes in the sum of exports, net capital imports, and






the previous current account balance, on national money in-

come, and imports, with the theoretical linkage between the

variables, changes in the money supply and domestic economic

activity, being determined by the interrelationship between

the money market and the goods market. In an open economy,

this interrelationship between the money market and the goods

market implies that an increase in domestic assets, exports

and net capital imports creates an excess supply of money, in

the money market,which is assumed to be instantaneously trans-

mitted to the goods market by the increase in the community's

aggregate demand for both foreign and domestically produced

goods and services. On this theoretical basis Holtrop esti-

mated four equations with two of the four equations being

specified as follows:

(1 1) LYn = c + alLcr + aE

(1 2) L.M = c + blLcr + b2E

where

Lcr = Domestic monetary impulses = The lN2 definition
of the money supply minus the net holdings of foreign
assets within the banking system = Domestic Credit.

E = External monetary impulses = increases in exports
plus net inflow of foreign capital plus the current
account surplus of the previous year.

LY = changes in nominal national income.

ALM = changes in imports.


The results from the regression analysis indicate that there

exists "a high degree of correlation between monetary impulses

and the sum of changes in the nominal national income and the

import of goods and services" (Holtrop, 1972, p. 273).







Holtrop concludes on this basis that "the potential long-term

impact of monetary policy on total volume of spending and

consequently, on growth, on the price level, and on the balance

of payments is considered to be beyond doubt" (Holtrop,

1972, p. 283).

The results from the Holtrop study, while offering on

the one hand fairly strong support for the process of adjust-

ment according to the Quantity Theory of Money in an open-

economy under a system of fixed exchange rates, are on the

other hand subject to the criticism that it suggestsdomestic

monetary policy can exert a significant and powerful effect

on income in the long-run. This view conflicts with the more

or less general view emanating from the literature that expan-

sionary domestic monetary policy in an open-economy will, if

at all, only increase income in the short-run, as the increases

in expenditures associated with the increase in domestic

assets will eventually all fall on imported goods and thereby

leak out of the system. This consequently means that both

income and imports will return to their original level fol-

lowing the exhaustion of the additional liquidity on imported

goods and services.

Coppock (1962) and MacBean (1966) in their respective

studies have examined the hypothesis that fluctuations in

economic activity in the'less developed countries are caused

by fluctuations in the export earnings of these countries, that

is

(1 3) IY = c + b ,IX

where




5

IY = instability in money income.

IX = instability in export earnings.

This hypothesis is based first on the mechanism of adjustment

which follows when there is an increase (decrease) in export

earnings. Second, on the assumption that the magnitude of

the annual changes in export earnings in the LDC's are very

large, because their exports consist primarily of primary

products that are concentrated upon too few products and too

few trading partners, that is:

(1 4) IX = a + blPR + b2CC + b3GC

where

PR = ratio of primary product exports to total exports.

CC = commodity concentration

GC = geographic concentration

The empirical evidence presented first by Coppock and

subsequently by MacBean failed to produce a general rejection

of the null hypothesis (i.e., bl=0; b2=0; b3=0), in equations

(1-3) and (1-4).

In this study, it is anticipated that further insights

into the relationship between fluctuations in economic

activity and fluctuations in export earnings can be achieved

by looking at the process of adjustment within a single

country. Consequently the study will examine on the one

hand the degree of interrelationship between the money market

and the market for goods that are produced domestically.

It will also examine on the other hand whether the monetary

impulses resulting from the changes in exports are offset

by any countervailing domestic monetary policies.







A further look at the process of adjustment in an open

economy in response to changes in money flows will be made

in accordance with the new monetary approach to balance of

payments theory,(Frenkel, 1971; Johnson, 1972; Komiya, 1969;

Mundell, 1968; chap. 9). This theory emphasizes basically the

impact on the balance of payments of changes in the factors

that determine the demand for money. The empirical studies

(Bean, 1976; Genberg, 1976; Guitian, 1976; Magee, 1976;

Zecher, 1976) which have examined this new approach to

balance of payments adjustment have been case studies on

countries in which the capital market is highly developed.

The demand for money function in these studies is therefore

assumed to depend not only upon income but also upon the

interest rate. Consequently the following reserve flow

equation was estimated:

(1 5)

r = (R/R + D)gr = a g. + a g a3g. b m b (D/R + D)gd
1 2 p i m 2 d

where

gr = growth in foreign assets

g = growth in real income

g = growth in domestic price level
P
g = growth in interest rate

g = growth in money multiplier

gd = growth in domestic assets


Genberg in a study on the factors that determine changes in

the flow of foreign reserves in Sweden also allows for the

use of sterilization policies to offset the monetary impulses







emanating from the balance of payments by estimating in con-

junction with equation (1-5), the follwoing equation:

(1 6) d + (D/R + D)gd = b3(R/R + D)gr + b4gGD

where

gGD + growth in government budget deficit.
In this stud' a slightly modified reserve flow equation

will be estimated because it is assumed that money balances

in Guyana are held primarily for transaction purposes. This

study will also take a specific look at the effects of the

financing of the government's budget deficit by money creation

on the balance of payments. It is expected that in the

absence of economic growth, the credit financing of the

government's budget deficit will only result in the reduction

in the country's foreign assets.

In Chapter II a further analysis of the theoretical

ideas which underlie the issues raised in this introduction

will be discussed. It will be seen that the works of David

Hume (1752) provide the initial ideas on the balance of pay-

ments and balance of payments adjustment, regardless as to

whether it is discussed in terms of the new monetary approach

to balance of payments theory, or in terms of the classical

notions of the quantity theory of money.













CHAPTER II

THE ROLE OF MONEY III THE PROCESS OF
INTERNATIONAL ADJUSTMENT



This chapter provides the main theoretical ideas which

will be used as the basis for the analysis of the issues

raised in Chapter I. Basically the two issues are raising

a fundamental question, namely, what is the process of

adjustment in an open economy which is operative at all

times and which consequently ensures that the demand for

money is always equal to the money supply? The answer to

this question was initially provided by David Hume (1752)

who developed the price-specie flow mechanism on the basis

that domestic money and international money are identical.

Thus according to Hume a surplus in the balance of payments

will increase the money supply and this will via the

quantity theory of money subsequently increase prices.

The increase in the price level, when there is a surplus in

the balance of payments will consequently make the exports

of the country relatively expensive and its imports relatively

inexpensive. This increase in the price of the country's

exports and the decrease in the price of its imports will

give rise to changes in Lrade flows namely, an increase in

imports and a decrease in exports, which will thereby lead







to an outflow of international reserves and thus a contrac-

tion in the domestic money supply and the subsequent correc-

tion of the imbalance in the balance of payments.

This adjustment mechanism of David Hume (1752), was on

the one hand modified by Polak (1957-58) and Prais (1959-1961)

to reflect the shift in emphasis away from the effect of

changes in the money supply on the relative national price

level, to the effect of changes in the money supply on

domestic expenditures, and consequently the changes in domestic

expenditures as the means for eliminating the surplus or

deficit in the balance of payments. On the other hand, the

adjustment mechanism, was further modified by Frenkel (1971),

Johnson (1972), Komiya (1969) and Mundell (1968), to reflect

the shift in emphasis away from the simple to the modern ver-

sion of the quantity theory of money. Further modifications

were also introduced to reflect the increasing importance of

credit issued by the commercial banks and the Central Bank

which had developed from the system of holding fractional in-

ternational reserves. Allowance was also made for the adjust-

ment to occur not only through changes in trade flows but also

through changes in flow of short-term capital in response to

differentials in the interest rate.

In the following section a very simple model of the

adjustment process in an open economy will be presented first

in terms of the simple version of the quantity theory of

money and then in terms of the new approach to balance of

payments theory which emphasizes adjustments according to






changes in the determinants of the demand for money. The

final section will then discuss some implications of the

adjustment process as far as the possible use of domestic

monetary policy and government budgetary policy are concerned.

The Mechanism of Adjustment in an Open Economy According to
the Quantity Theory of Money

In an open economy under a system of fixed exchange

rates, a surplus in the balance of payments will persist until

the increases in the quantity of money and the subsequent in-

creases in domestic expenditures are just sufficient to elim-

inate the surplus from the balance of payments.

The theory underlying this adjustment process can be

expressed in terms of the following equations. The first

equation is the Cambridge demand for money function which

relates the demand for nominal money balances to the level

of nominal income:

(2 1) MId = kY

where

Md = demand for nominal money balances.

Y = nominal income.

with nominal income by definition being equal to the price

level times output:

(2 la) Y = Py

where

P = domestic price level

y = real output

The second equation defines the process of money creation on

the basis of the consoli'!ited accounts of the banking system







which requires according to accounting principles that the

monetary liabilities of the system correspond to the sum of

foreign and domestic assets held by the banking system, that

is:

(2 2) s E P. + D


where


Ms

R

D

Changes

foreign

(2


= money supply

= foreign assets

= domestic assets

in the money supply therefore occur through changes in

and/or domestic assets:

- 2a) dMs E dR + dD
dt dt dt


where


dMs = changes in
dt

dR = changes in
dt

dD = changes in
dt


the money supply


foreign assets


domestic assets


The third equation is a definitional equation of the balance


payments:

(2 3)

where


B dR
dt


X i + v~


dRp
C- B = balance of payments

X = exports of goods and services

I = imports of goods and services

K = net autonomous inflows of capital to the
non-banking sector.




12

The fourth equation is the domestic expenditure equation, with

domestic expenditures being dependent upon income and liquidity.

It is assumed that an increase in income and the money supply

will increase domestic expenditures while an increase in the

demand for money will reduce domestic expenditures:

(2 4) C = Y + a (Ms Md)

where

c = domestic expenditures

and with equilibrium in the monetary sector, income will be

equal to domestic expenditures.

The fifth equation is the import function which expresses

imports as a fraction of income:

(2 5) I = mY

The sixth and seventh equations assume that exports and net

capital inflows are exogenously determined:

(2 6) X = :o

and (2 7) K = Ko

In the following equation national income is defined as

the sum of domestic expenditures and the balance on current

account:

(2 8) Y = C + : T

Thus starting from a position of initial equilibrium, that is,

the demand for money equals to the supply of money, domestic

expenditures equal to income, and imports equal to the sum of

exports and net capital inflows; (according to equation 2-8)

an increase in exports will lead to an increase in income,

which will according to equation (2-1) cause the demand

for money to increase. The increase in exports will






also according to equations (2-3) and (2-2a) improve the

balance of payments and hence increase the money supply. This

increase in the money supply does not occur instantaneously.

Thus during the initial stages of the expansion in exports the

scarcity in liquidity will according to equation (2-4), tend

to depress domestic expenditures below income as the public

attempts to build up their cash balances. However as the

money supply increases there will be even further increases

in domestic expenditures which will tend to increase income,

imports and the demand for money.

This process of adjustment would continue until the

change in the demand for money correspond to the change in

the money supply, the change in imports equals the change

in exports and net capital inflow, and until the change in

domestic expenditures equals the change in income. Thus for

every given increase in exports one can envisage a continuous

process of adjustment which starts by effecting liquidity,

domestic expenditures, income, and imports with the process

coming to an end when the surplus (deficit) in the balance

of payments is eliminated.

Following Polak and Argy (1971), the effects of an

increase in exports and net capital inflow on income, the

balance of payments, the money supply,and on imports can be

derived by' assuming that there is equilibrium in the money

market, that is:

(2 la) kY = R + D

where

k = 1
g.





14

Following this, equations (2-la) and (2-3) are expressed in

first difference form hence

(2 Ib) kY = iR + AD

and

(2 -3a) B = iR = L: AI + sK + B-1

Furthermore by assuming that the change in reserves and income

is constant in equilibrium, the following long-run solutions

are obtained when equation (2-3a) is substituted into equation

(2-1b):

(2 9) L = 1 ( + K)


(2 10) B = 1 ,(x + K) LD
my

(2 11) i..s = L(X + K)

and

(2 12)i I = cA(X + K)

One of the consequences of this process of adjustment

which must occur in the absence of countercyclical monetary

policy is the perpetual disturbance of internal stability

(Levin, 1960; Wallich, 1950), because as domestic expenditures

increase (decrease) in response to an increase (decrease) in

the money supply, money income also increase (decrease)

according to the proportion of domestic expenditures which

fall on domestic goods and services. This perpetual distur-

bance of internal stability has led to the thesis that economic

fluctuations in open economies are imported, since only a

change in exports or net capital inflow is required to affect

domestic expenditures.






In the less developed countries, the principal source

of the disturbance in domestic economic activity is identi-

fied as the LDC's export earnings because these countries

have specialized in primary products and because their

exported goods are heavily concentrated upon too few products

and also because their trade is concentrated to too few

countries (MacBean, 1966; United nations, 1952; Wallich, 1950),

that is:

(2 13) IX = a + blPR + b2CC + b3GC

where

IX = instability in export earnings

PR = primary product ratio

CC = degree of commodity concentration

GC = degree of geographic concentration

Consequnetly, it is argued that it is the extremely volatile

nature of the LDC's export earnings which by upsetting in-

ternal stability causes in the short-run fluctuations or in-

stability in money income (Holtrop, 1963; Levin, 1960;

Wallich, 1950). This relationship between fluctuations in

export earnings and money income is expressed as follows:

(2 14) IY = C + b IX

where

IY = instability in money income

Furthermore, it is also argued since part of the adjustment

procPss entails the increase (decrease) in imports for every

increase (decrease) in exports (Harrod, 1973; pp. 120-121;

Holtrop, 1972; Polak, 1956-58; Polak and Argy, 1971) and

since imports of non-essential goods and services are cut

to the minimum, in conjunction with the LDC's being dependent






upon international trade as a means of obtaining their capital

equipment for domestic investment, that the fluctuations in

export earnings would generate similar fluctuations in domestic

investment (MacBean, 1966, p. 69) that is:

(2 15) IV = a + b IX

where

IV = instability in domestic investment

IX = instability in export earnings

The discussion so far has examined the process of

adjustment and the consequence for internal stability when

there is a surplus or deficit in the balance of payments.

The next section will discuss the adjustment process in terms

of changes in the factors that determine the demand for money

rather than the factors that determine the changes in the

money supply. Consequently changes in the factors that

determine the demand for money which in this case is the

domestic price level and real income are considered as being

exogenously determined. The changes in the domestic price

level are assumed to occur primarily through changes in the

world price level, whilst changes in real income is deter-

mined by changes in productivity and factors of production.

The Mechanism of Adjustment in an Open Economy According to
the New Monetary Approach to Balance of Payments Theory

In this section the emphasis will be focused on the

process of adjustment in the balance-of-payments due to

changes in the factors that determine the demand for money.

This rnmphasis on the adjustment process in response to changes

in the factors that determine the demand for money, represents





17

the new monetary approach to the balance of payments theory.

(Johnson, 1972; Komiya, 1969; Nlundell, 1963, chap. 9). This

new approach to balance theory and balance of payments ad-

justment owes its theoretical principles to the price-specie-

flow mechanism of David Hume (1752) with the exception being

that the mechanism of adjustment has shifted from changes in

relative national price levels to the effects of liquidity

changes on the balance between income and domestic expenditures

and thereby to the subsequent effects of domestic expenditures

on the balance of payments.

In this new approach the emphasis is placed on the

changes in liquidity and hence the changes in domestic expen-

ditures which occur through changes in the factors that

determine the demand for money, which was specified as follows:

(2 lb) Md = kPy

An autonomous increase in real income will increase the

demand for money and thereby create a stock disequilibrium

in the money market. This increase in the demand for money

will also result in the reduction in domestic expenditures,

as people attempt to maintain their existing money balances.

In an open economy, this reduction in domestic expenditures

will generate a surplus in the balance of payments. This

impact of an exogeneous increase in real income on the

balance of payments runs counter to the Keynesian view of the

relationship between increases in real income and th-

balance of payments.

In the Keynesian approach, it is suggested that increases

in real income will result in the deterioration of the balance







of payments (Dernburg and MacDougall, 1972, p. 268; Johnson,

1954; Kindleberger, 1973, p. 389; Meier, 1968, pp. 73-75). In

that analysis it is assumed that the income elasticity of im-

port demand is positive and for small economies that the

relative prices of traded commodities remain unchanged. Thus

an increase in real income will, by increasing imports cause

a deterioration in the balance of payments. Furthermore if it

is assumed that the income elasticity of import demand is

identical for all countries; then the country that grows

relatively faster than its trading partners will experience

a deterioration in its balance of payments relative to its

trading partners. The Keynesian approach to the relationship

between economic growth and the balance of payments, in con-

trast to the monetary approach, considers only the effects

of the increase in real income on the demand for imports and

neglects the effects of the changes in real income on the

demand for money' and the subsequent effects of the changes in

the demand for money on domestic expenditures (Johnson, 1972;

Komiya, 1969; Mragee, 1976; Polak, 1956-58, p. 26).

The demand for money is also affected by changes in the

price level. An increase in the domestic price level will

improve the balance of payments, since the increase in the

price level reduces the existing holding of real money

balances. This will then result in an increased demand for

money, which will be satisfied by an inflow of international

reserves. It is assumed that these changes in prices will

according to the small country assumption reflect basically

changes in the world price level, rather than changes in the






country's price level relative to the world price level.

If the changes reflect changes in the countries price level

relative to the .world price level, then there would be an

inverse relationship between changes in prices and the flow

of reserves as increases in the domestic price level will

result in the substitution of foreign goods for domestic

goods.

Although according to equation (2-1) the demand for

money is determined primarily by the public's need to carry

out economic transactions. The interest rate in other eco-

nomies with highly developed capital markets, becomes an

important variable in explaining the demand for money.

Consequently, an increase in the interest rate will by re-

ducing the demand for money, cause an outflow of reserves.

The interest rate, like the price level is also determined

exogenously in the world market, so that for individual

countries the changes in the interest rate is merely a re-

flection of changes in the world interest rate. If the

changes in the interest rate are interpreted as a change in

the respective country's interest rate relative to the rest

of the world, then such changes should attract foreign

capital and lead to an improvement in the balance of payments.

To recapitulate, the discussion so far has focused on

the process of adjustment which ensues when monetary equili-

brium in an open economy under a system of fixed exchange

rates is disturbed by either a surplus (deficit) in the

balance of payments or by a change in the factors that deter-

mine the demand for money. This process of adjustment which




20

occurs in order that equilibrium in the monetary sector may

be maintained, however poses severe limitations on the use

of domestic financial policies, because the excessive use of

domestic financial policies results in the outflow of foreign

assets. The discussion in the next section will consequently

look into the effects of domestic financial policies on the

balance of payments.

Domestic Financial Policy
2
The harmful effects of domestic financial policies on

the balance of payments result from the assumed independence

between these policies and income and its direct effect on

domestic expenditure (Johnson, 1972; Komiya, 1969; Magee,

1976; Polak, 1956-58, p. 26). Thus the increase in bank

credit will increase liquidity in the economy and because it

has no effect on output and therefore on the demand for

money, domestic expenditures will increase as the community

attempts to reduce their excess holdings of money. This

increase in domestic expenditures will result in a net out-

flow of foreign assets and consequently the deterioration

in the balance of payments as the increase in domestic

expenditures on imports was neither initiated nor supported

by any prior inflow of foreign assets.

The inability of domestic financial policy to influence

output in the long-run, imposes serious restrictions on the

monetary authority's ability to control the domestic money

supply. In fact as a result of the process of adjustment,

the use of domestic monetary policy will only affect the

composition of the Central Bank's total assets, since with no






growth in income and with a constant price level, growth in

bank credit will be completely offset by an outflow of foreign

assets (Johnson,1972). This inverse relationship between

domestic assets and the balance of payments is expressed as

follows:

(2 16) r = (R/R + D)g, = -(D/R + D)gd

If the use of domestic financial policies does affect

the rate of capital formation and subsequently causes an

increase in income and the demand for money, there will be

an offsetting tendency for the community' to reduce their

expenditures as they attempt to hold part of the liquidity

injected into the system in the form of additional money

balances (Dornbusch, 1971; Mundell, 1971; chap. 4). This

would consequently tend to offset the full leakage of bank

credit out of the system and thereby dampen the harmful

effects of domestic monetary and fiscal policies on the

balance of payments.















Notes



As Samuelson (J.I.E., 1971) has pointed out, this process
does not correctly treat traded goods, whose prices are
equalized through trade and therefore cannot move in op-
posite directions.

2Domestic financial policy is defined as a mix of monetary
and fiscal policies, with the assumption that monetary
policy occurs in the form of changes in bank credit while
fiscal policy occurs in the form of changes in the portion
of the government's budget deficit that is financed by bank
credit. The latter method of financing the government's
budget is tantamount to monetary policy.














CHAPTER III

MONETARY ARRANGEMENTS IN GUYANA



The discussion in the previous chapter has raised several

notions concerning the monetary process of adjustment in an

open economy. These notions, in keeping with the objectives

of the study, will be tested on the basis of the economic

experience of Guyana. It is therefore necessary before em-

barking upon the empirical testing of these notions, to pro-

vide some background information on Guyana covering the

period between 1955-1973. Consequently, this chapter is

designed to present information on the salient economic

features of the Guyanese economy. This look at the Guyanese

economy in accordance with the overall theme of the study,

will emphasize, the past and present system of monetary

arrangements in the economy. This will entail looking at

the Currency Board System, the functions and regulatory tools

of the Central Bank, in conjunction with a look at the ob-

jectives of monetary policy since the establishment of the

Central Bank.

The Monetary System

The monetary system of Guyana for the period between

1955-1973 has developed in close conformity to what has be-

come known as the Sterling Exchange Standard. This standard





according to Sayers (1967, pp. 134-144) has developed from

the use of London as a base for transferring clams between

countries. The Sterling Exchange Standard is moreover charac-

terized by the holding of sterling balances in London and the

maintenance of a fixed parity between the various countries

domestic currencies and the British pound. For the British

Dependencies and Colonies, their involvement in the Sterling

Exchange Standard was enhanced by the establishment of the

Currency Boards.

Currency Board System in Guyana

In the period between 1955 to 1966 when Guyana was a British

Colony (and consequently known as British Guiana), the unit

of account was the British West Indian dollar. This currency

was issued by the British Caribbean Currency Board (Eastern

Group) with the value of one West Indian dollar being equal

to four shillings and two pence.

The operation of this system has been described by

several writers (Clauson, 1944; Greaves, 1953; Bloomfield,

1961). It involves basically the automatic interchanging of

local currency with sterling at a fixed rate. The system

is furthermore characterized by the requirement that all of

the monetary liabilities, that is, notes and coins of the

Currency Board, be supported by 100 percent sterling reserves.

These reserves were then invested by the Currency Board in

British and other colonial governments' securities. The net

proceeds from these investments would then be held by the

Currency Board until its holding of sterling reserves had

increased to the upper limit of 110 percent. After this




25

limit was reached, the proceeds from the investment would then

be returned to the Colony. In 1954 a change in policy per-

mitted the Currency Board to back part of its monetary li-

abilities with domestic assets.

This change in policy, as far as Guyana is concerned, did

not produce any perceptible change in the Board's operation.

In fact according to the data presented in Table I, the policy

seems to have been effectively implemented in 1960, since in

that year the proportion of domestic assets in total assets in-

creased from about 6 percent in 1959 to about 20 percent in

1960. According to Thomas (1965) this late implementation of

the policy resulted from the "lack of initiative by the

participating governments" (p. 26).

Despite the modifications which were introduced in 1954,

most writers (Bloomfield, 1961; Clauson, 1944; Grea'.ves, 1953)

readily concede that the opreations of the Currency Board was

automatic and passive. In fact if it is assumed that the

changes in domestic credit remains relatively constant then

the functioning of the Currency Board under the Sterling Ex-

change Standard is reminiscent of the simple specie currency

mechanism, since a surplus in the balance of payments will

give rise to an increase in sterling balances and a corre-

sponding increase in the money supply. This functioning of

the Currency Board as a mere money changer has led to the conclu

sion that the operation of the Currency Board System naturally

precludes the use of monetary policy as a stabilization

device (Bloomfield, 1961; Clauson, 1944). This rigidity

in the operation of the Currency Board System coupled with













TABLE III-1

GUYANA'S MONEY SUPPLY, NET FOREIGN ASSETS
AND DOMESTIC ASSETS


(Figures in Millions of Guyana Dollars)


Year Money Supply Net Foreign Assets Domestic Assets

1955 25.6 25.0 .6

1956 26.3 28.2 -1.9

1957 28..5 30.6 -2.1

1958 30.4 29.2 1.0

1959 34.8 32.8 2.1

1960 37.8 26.8 11.0

1961 36.3 26.9 9.3

1962 41.7 37.1 4.6

1963 43.3 54.0 -10.6

1964 47.3 59.6 -12.4

1965 45.2 46.8 -1.6

1966 46.7 34.9 11.2

1967 53.0 48.9 4.0

1968 56.9 47.0 9.8

1969 59.7 37.4 22.2

1970 59.0 35.2 22.8

1971 66.9 46.8 20.1

1972 82.1 67.6 14.5

1973 93.7 23.2 70.5

Source: International Financial Statistics




27

the movement towards political independence led to the legal

establishment of the Bank of Guyana in 1965. However, in

order to make the transfer of control from one authority to

another as smooth as possible, the British Carribean Currency

Board (Eastern Group) was eventually dissovled in 1967.

Central Banking and rNonetary Policy in Guyana

The principle objective of the Bank of Guyana as stated

in the Bank of Guyana Act, 1965 is that of "fostering mone-

tary stability and promoting credit and exchange conditions con-

ducive to the growth of the economy of Guyana" (Bank of Guyana,

Annual Report, 1966). The Act provided to the Bank $6 million

as its authorized capital. The Act also provides for the

establishment of a Board of Directors, whose orimary function

is to formulate the Bank's policy. This Board is comprised of

four or five members with the Governor of the Bank and the

Bank Banager serving as the Chairman and Deputy Chairman,

respectively. Both the Governor and the Bank Manager are

appointed to the Board for a period not exceeding five years;

whilst the two or three other Board members are appointed for a

period not exceeding four years.

The Bank in the performance of its duties is solely

responsible for issuing notes and coins in Guyana. It is

furthermore required by the Act, to maintain at all times

assets whose value correspond to the value of the total amount

of notes and coins in circulation. According to the Act, the

value of the assets are to be distributed in such a manner

that at least 50 percent of the value of the total amount of

notes and coins are to be backed by foreign assets. The Act




28
also requires that the Bank of Guyana act as Banker to the

commercial banks and the government. It consequently in

the performance of these duties buys,sells, and rediscounts

bills of exchange, promissory notes and other instruments

of credit from commercial banks. It also buys and sells

government securities, dealsin foreign exchange, services the

public debt and in general perform the normal operations of

a Central Bank. The Bank is also empowered to make direct

advances to the government when there is a shortfall in

government revenue. The Act also stipulates that the maxi-

mum amount which the Bank can advance at any given moment

to the government is to be 15 percent of the average annual

government revenues for the last three years. The govern-

ment is furthermore required to repay this advance within 350

days. The Bank is also prevented from holding government

securities in excess of 30 percent of the average annual

government revenue for the previous three years.

The Act entrusts the Bank with tools which it can use

to regulate the supply of money and bank credit in the econ-

omy. The Bank can vary the minimum reserve requirements that

the commercial banks are required to maintain on their

demand and time deposits. The Bank also determines the per-

centage of total liabilities which the commercial banks are

required to maintain in the form of liquid assets, fix the

rate interest which the commercial bank pay on its deposits,

or charge on its loan,and fix the discount rate.






The primary objective of monetary policy during the

period 1965 to 1973 has been to attempt to shift the allocation

of bank credit from those uses which result in an increase

in consumption to those uses which would increase production

(Bank of Guyana, Annual Report, 1966, 1968, 1970, 1972, 1973).

The Bank in attempting to achieve this objective has used

moral suasion as its chief weapon. In its endeavour to

dampen the drain on the banking system holding of foreign

assets, the Bank has urged the government to pursue a policy

of fiscal restraint by balancing its budget. The Bank had

also imposed the requirement of 100 percent advance deposits

on imports, during the period, November 16, 1966 to October

12, 1967.













CHAPTER IV

AN EMPIRICAL INVESTIGATION OF THE PROCESS OF
ADJUSTMENT ACCORDING TO THE QUANTITY THEORY OF MONEY



In this chapter an empirical analysis of the process

of adjustment according to the quantity theory of money in

an open economy will be presented.

The first issue which will be taken up is the inte-

gration of the Guyana economy into the world economy. This

question will be examined by looking at the changes in

money income which are accounted for by changes in exports

and net capital inflows. The integration of the Guyana

economy into the world economy under a system of fixed ex-

change rates also implies that there is a close linkage

between the balance of oavments and the money supply, with

the money supply expanding or contracting according to

whether there is a surplus or deficit in the balance of

payments. This close linkage between the balance of pay-

ments and the money supply leads to the thesis that changes

in the money supply are induced by changes in exports and

net capital inflows. Estimates of this relationship will

be provided. It will also be seen that the impact of a

change in exports and net capital inflow on the money supply

and on the country's foreign assets could be large or

small according to whether the marginal propensity to import

and the income velocity of money are large or small.

30







The second issue which will be examined is whether

accompanying this integration into the world market, there

have been excessive changes or fluctuations in income due

to the changes in foreign demand for the country's exports.

The degree of excessive changes or instability in export

earnings and in income will be estimated by using the

Massell (1970) index of instability.1 This thesis of in-

stability or excessive fluctuations in domestic economic

activity has developed from the basic openness of the

economy which according to the process of adjustment as out-

lined in Chaoter II, requires domestic expenditures and

hence income and imports to change in such a manner that

equilibrium in the external sector is always maintained.

The contraction and expansion of domestic economic activity

in accordance with the deficits and surpluses which the

decreases and increases in exports are able to generate in

the balance of payments implies that there is no offset to

the monetary impulses emanating from the balance of payments.

The last section of this chapter will therefore present

estimates of the balance of payments equation, under two

assumptions: first, that there is no offset to the mone-

tary impulses emanating from the balance of payments, and

secondly, that there is some offset to these monetary

imoulses.

Market Integration

In an open economy the hypothesis that the domestic

economy is integrated into the world economy will be






tested by examining the effects of changes in external

transactions on domestic money income. Following Polak

and Argy (1971) the following equation is estimated:

(4 1)
1
'\ = 4(X + E) + u
m
where

LY = changes in national money income

A(:. + K) = changes in the sum of exports and net
autonomous capital inflow into the non-
monetary sector.

u = error term.

It is anticipated that the foreign trade multiplier,
1
', should have a value which is greater than one, since an

increase in exports and net capital inflows will bv in-

creasing the money supply lead to an excess demand for

goods and services as the community attempts to reduce their

holdings of money.

Holtrop t1972), in a study on the monetary experience

of the Netherlands economy, finds that the changes in both

domestic and external monetary impulses expressed as a

percentage of the money supply do exert a very significant

impact on the changes in spending as indicated by the

changes in nominal income. A correlation coefficient of

.83 was obtained from the regression.

For Guyana, only the relationship between the external

monetary impulses, that is the changes in the sum of ex-

ports and net capital inflow, and nominal income is con-

sidered. because according to Polak (1956-58) and Polak

and Argy (1971). changes in domestic assets have no effect







on money income in the long-run. The estimation of

equation (4 1) for the period 1956 through 1973 yielded

the following results which are shown in the equation

below:

L.Y = .81 Z(X + F.), D-W = 2.45
(4.62)

with the figures in parenthesis being the t-statistics.

The equation was first estimated with the raw data for

income, exports and net inflow of foreign capital. The

Durbin-Watson statistic however indicated that the distur-

bance terms were not independent of each other and this

consequently made the estimated coefficient for the income

foreign trade multiplier less efficient, since there is

some other linear method of estimation which if applied

to the equation would yeild an estimated coefficient with a

smaller variance (Johnston, 1972, chap. 8; Kmenta, 1971,

pp. 273-278). Therefore, in order to reduce the serial

dependence among the successive observations, it was

necessary to transform the variables in the equation

according to the following scheme: G .18Gt-1 + .25Gt_2-

The coefficient for the income foreign trade multiplier

was then estimated by applvina ordinary" least-squares to

the transformed data. The results as shown indicate that

the multiplier effect on income of a change in export and

net capital inflow is below its anticipated value. Further

consideration indicates that changes in real income may

actually be independent of changes in exports and net

capital inflow, since with money income by definition






being equal to the domestic price level and real income:

(2 la) = Pv

and with the domestic price level, P, being pegged to the

world price level v.ia the exchange rate:

(4 2) P = eP*

where

P* = world price level

Changes in money income should therefore occur primarily

through changes in real income.

The Money: Supply Process

In a closed economy, the central bank controls the

process of money creation by varying the amount of securities

it buys and sells on the open market, by varying the mini-

mum reserve requirements on deposits, by varying the dis-

count rate, and also by varying other non-quantifiable

policies which are generally known as moral suasion.

In an open economy the central bank. by committing it-

self to exchanging foreign currency, for domestic money at

a fixed parity, lose its ability to control the process of

money creation. Instead the process of money creation is

controlled by the changes in exports and net capital in-

flow, and the public's demand for money and imports. In

order to see how the process of liquidity creation works

in an open economy, and in order to see the importance of

the public's demand for money and imports imagine that

there is an increase in exports which will affect income

in accordance with the proportion of export earnings that

is actually expended on domestic goods and services. This






increase in domestic money income will then according to

the proportion of income that the community wants to hold

in the form of money, lead to an increase in the demand

for money and hence when in equilibrium to an increase in

the money supply. To test, for Guyana, the hypothesis

that in an open economy it is increases in exports and net

capital inflow which controls the process of liquidity

creation, the following equation is estimated by ordinary

least-squares:

(4 3) Mls (X + K

The raw data for the variables in the equation were trans-

formed by the following function: Ht .29Ht1 + .21H_2, in

order that the serial dependence among the error terms may

be reduced. The following results were obtained when ordinary

least squares was applied to the transformed data:

LAM = .09 (X + K) D-W = 1.43
(4.62)

The results indicate that the coefficient for the changes in

the sum of exports and net capital inflow is statistically

significant.

The Choice Between External Eauilibrium and Internal Stability

One of the consequences of having an open economy is

that there must be continuous internal adjustment in the level

of economic activity, if equilibrium is to be maintained in

the balance of payments. Thus whenever there is a change in

foreign demand for the country's exports which consequently

leads to a surplus or deficit in the balance of payments;

the domestic economy, in the absence of countercyclical policy,






must adjust in such a manner that the surplus or deficit

in the balance of payments is eliminated. The increase

(decrease) in exports will therefore either through the

Kevnesian income effect and/or the classical cash balance

effect increase (decrease) domestic expenditures which in the

final analysis will increase (decrease) nominal income

according to the proportion of domestic expenditures which

is expended on domestic goods and services. This resulting

increase (decrease) in nominal income will subsequently

lead to an increase (decrease) in imports and an outflow

(inflow) of foreign assets, which will thereby correct the

disequilibrium in the balance of payments (Polak, 1951-58,

pp. 19-24; Prais, 1959-1961). This process of internal

adjustment therefore creates a problem for policy makers

who are forced to choose between either maintaining external

equilibrium or internal stability.

In the developing countries this process of internal

adjustment is further accentuated as the export earnings of

these countries are subject to greater volatility than the

export earnings of the developed countries. J. D. Coppock

(1962) in an empirical analysis of the causes and effects

of instability in export earnings, finds for the period

1946 to 1958, that the less developed countries had a mean

instability in export earnings which was 31 percent higher

in comparison to the instability in export earnings of the

developed countries. Guy P. Erb and Salvatore Schiavo-Campo

(1969) computed on a similar basis as the Coppock study,






instability indices for developed and less developed countries

for the period 1954 to 1966. The results indicated that the

mean instability in export earnings for the LDC's was 117

percent higher than in the developed countries. Massell

(1970) also finds for period 1950 to 1966 that the export

earnings from the less developed countries were subject to

50 percent more instability than the export earnings from

the developed countries. The calculated degree of instability

in export earnings for LDC's and DC's according to the three

studies are shown in Table IV-1.


TABLE IV-1

CALCULATED INDICES OF INSTABILITY IIN EXPORT
EARNINGS FOR THE LESS DEVELOPED AND DEVELOPED COUNTRIES


MEAN IN-
TIM.E STABILITY INDICES
STUDY PERIOD LDC's DC's

Coppock (1962) 1946-53 23.1 17.6

Erb and
Schiavo-Campo (1969) 1954-66 13.4 6.2

Massell (1970) 1950-66 .142 .025

Sources: (a) Coppock, 1962: Table A-2 and Mac Bean, 1966,
p. 35.

(b) Erb and Schiavo-Campo, Bulletin Oxford Uni-
versity Institute of Economics and Statistics,
1969.

(c) Massell, American Economic Review, 1970


Causes of Excessive Fluctuations in Export Earnings

Three hypotheses have been formulated to explain the

underlying cause for the higher degree of instability in

the export earnings of the less developed countries. The






first of these hypotheses is that since most of the less

developed countries are specialized in exporting primary

products, the cause of the extra degree of instability in their

export earnings could be attributed to their specialization in

primary products. This hypothesis also implies that the

export earnings from primary products are also relatively

more unstable than that obtained from exporting manufactured

products (MacBean, 1966, p. 36).

The empirical examination of this hypothesis by Coppock

(1962) and Massell (1964, 1970) failed to substantiate the

a priori reasoning of the effects of specialization in

primary products on the fluctuations in export earnings.

Coppock in his study found, contrary to expectations, that

export earnings of manufactured products were relatively more

unstable than the export earnings from primary products.

Coppock calculated an instability index of 6.8 for the ex-

port proceeds from manufactured products, while the instabil-

ity index for the export proceeds from primary products was

calculated to be 3.8. Massell in his 1964 paper, also finds

the relationship between instability in export earnings and

the ratio of primary products exports to total exports to

be relatively weak. In his 1970 paper, the insignificance

of the ratio of raw materials exports to total exports and

the significance of the negative coefficient for the ratio

of food exports to total exports, when regressed on an in-

stability index for export earnings led Massell to the con-

clusion, "that there is no tendency for primary products







to be more unstable than manufactures (net of other variables)"

(p. 628).

A second factor which has been identified as a plausible

factor in explaining instability in export earnings for the

less developed countries is the concentration of their ex-

ports to particular regions or countries. This hypothesis

goes as follows: the geographic concentration of trade has

diminished the ability of the LDC's to offset fluctuations

in demand in one region or country by increasing their ex-

ports to some other region or country (MacBean, 1966; p.44).

The empirical studies which have looked at this re-

lationship between instability in export earnings and geo-

graphic concentration have however failed to substantiate

this hypothesis. Coppock (1962), in his analysis correlated

the index of instability in export earnings with the index

of geographic concentration as determined by Hisrchman

(1945) concentration index. The result from this correlation

was a correlation coefficient of -.13 which has one can see

is low in value and has the wrong sign. MacBean (1966) in

his study obtain a correlation coefficient for the relation-

ship between instability in export earnings and geographic

concentration which also had a negative sign and which was

insignificant at the 5 percent level. Massell in both his

1964 and 1970 papers finds the coefficient for the index of

geographic concentration to be insignificantly related to

instability in export earnings. In his 1964 and 1970

papers, the coefficient was negative whilst in his 1970

paper he obtained a positive coefficient for the index

of geographic concentration. Massell on this basis






concludes in the 1970 paper that geographic concentration

"appears to be unimportant as an explanatory variable"

(p. 628), for instability in export earnings.

A third factor, namely the concentration of the ex-

ports of the LDC's upon too few products has also been

identified as a probable explanatory variable for instability

in export earnings. This hypothesis is based on the argument

that the concentration upon too few products for exports

results in the reduction of "a country's chances of having

fluctuations in one direction in some of its exports offset or

ameliorated by counter fluctuations or stability in others"

(MacBean, 1966, p. 41). This argument has subsequently

led policy-makers in the developing countries to adopt

measures which are designed to increase the number of

exported products. Recent studies by Brainard and Cooper

(1968) and Massell (1970) however suggest that great care

must be given to the type of products which are actually

selected as a means of diversifying a country's exports,

since "there is some degree of correlation between receipts

from different pairs of goods" (Massell, 1970, p. 622).

This notion can be illustrated by considering two goods,

which yield export earnings corresponding to x and z respec-

tively. The variance in total earnings, E, is given by the

following formula:


(4 4) V(E) = V(x) + V(z) + 2 Cov(x,z)

= V(x) + V(z) + 2/ V() V(z)
-Xz'






where

V(E) = variance in total export earnings

V(x) = variance in earnings from product x.

V(z) = variance in earnings from product z.
C
/xz = correlation coefficient between x and z

From equation (3-4) one can see that the variance in

total export earnings will be larger than the sum of the

variance of the two products, if the correlation between the

export receipts from these two products is positive. Con-

versely, the variance in total export earnings will be

smaller than the sum of the variance of the two products, if

the correlation coefficient between the pair of goods exported

is negative. Similarly, if the export receipts from the two

goods are not correlated then the variance in total export

earnings will correspond to the sum of of the variance of

the individual products. Consequently, it is suggested

that the overall objective reducing the variability in

export earnings behind the attempt to diversify will

stand a better chance of being successful if the chosen

products are such that there is an inverse correlation

between them, that is -1 /P 0.
'xz -
The empirical studies (Coppock, 1962; Hassell, 1964,

1970; MacBean, 1966; Michaely, 1962) which have examined

the proposition that it is the lack of diversification which

has caused instability in export earnings have failed with

one exception to substantiate this proposition. Coppock

(1962) in his study computed four different indices of com-

modity concentration, which were then separately correlated






to the index of instability in export earnings. The cor-

relation coefficients which were obtained from these re-

gressions ranged from +.02 to +.11.

M. Michaely (1962) in his study on the other hand, finds

instability in export prices, to be significantly correlated

to commodity concentration. His study however probably does

not contribute much to the understanding of the problem of

commodity concentration since the index of instability used

merely looks at the average annual percentage changes in

prices without eliminating the trend factor from the series.

MacBean (1966) in his study obtains a very low and in-

significant correlation coefficient of -.07 when his index

of instability in export earnings is correlated with the com-

modity concentration index. On the basis of this result

MacBean suggests that there is "very little or no effect on

the stability of export earnings from commodity concentration."

(p. 41).

The results obtained by Massell in both his 1964 and 1970

papers represents, of the major studies on instability in

export earnings, the only source that has found commodity

concentration to be statistically significant to instability

in export earnings. In his 1964 paper he obtains a coeffi-

cient for commodity concentration that is statistically sig-

nificant at the 5 percent level, when the index of in-

stability in export earnings is regressed on the indicies of

commodity and geographic concentration. However, when the

index of geographic concentration is excluded as one of

the explanatory variables, and the instability index of

export earnings is regressed on the index of commodity con-






centration, the results yield an P that is very low in value

along with an estimated coefficient that is insignificant.

In view of the fact that the significance of the relationship

between instability in export earnings and commodity concen-

tration depends upon the specification of the model to include

both commodity and geographic concentration, Massell (1964) con-

cludes, "that the relationship between instability of export

is a tenuous one indeed" (p. 61).

In his 1970 paper, it is found that the index of com-

modity concentration along with the food ratio is statistically

significant at the 5 percent level when the index of insta-

bility in export earnings is regressed on a number of ex-

planatory variables: commodity concentration; the domestic

consumption ratio, an index of geographic concentration, the

food ratio, the raw materials ratio, the share of world trade,

per capital income, value of merchandise exports and a dummy

variable to differentiate between developed and less developed

countries. lassell consequently concludes that it is shifts

in foreign demand which cases instability in export earnings

(p. 627).

The general inability of the statistically tests to

corroborate what are plausible explanations for the excessive

degree of fluctuations in export earnings of the LDC's led

MacBean (1966, p. 55) to suggest that the causes of instability

in export earnings may be due to internal factors such as

war and local politics, instead of the various economic

factors such as specialization in primary products and the

concentration of trade to too few countries and too few

products.







For Guyana the hypothesis that in developing countries

instability in export earnings is casued by commodity and

geographic concentration and b',' the ratio of primary

products to total exports was first tested for the period

1956 to 1973. We later included a dunmmy variable to reflect

the political changes which occurred within the period.2

Table IV-2 presents the results that were obtained when the

following two equations were estimated by ordinary least

squares.

(4 5) IN = a + blPR + b2CC +b3GC + u

and

(4 6) IX = a + blPR + b CC + b3GC + b PL + u*

where

IV = instability in export earnings

PR = ratio of primary product exports to total exports

CC = commodity concentration index

GC = geographic concentration index

PL = 0 for the period 1956 to 1965
1 for the period 1966 to 1973

The results fail to support the hypothesis that for an LDC

export instability is caused by commodity and geographic con-

centration and the ratio of primary products to total exports.

The subsequent inclusion of the durnmy variable in the model

to reflect the political changes over the period considered

turns out to be significant at the 5 percent level. The inclusion

of the dummy, variable also increases the R2 from .15 to .32.














TABLE IV-2

CAUSES OF INSTABILITY IN EXPORT EARNINGS


DEPENDENT
VARIABLE CONSTANT PR CC GC PL

IX .03 -.04 -.003 .04
(.59) (-.80) (-.07) (1.26)

I: .02 -.012 +.013 -.018 -.010
(.45) (-.20) (.42) (-.37)(-1.75)


R2 D-W

.15 2.21


.32 2.36


Note: Figures in parenthesis = t-statistics; D-W = Durbin-
Watson Statistics.


Additional estimates of the magnitude of instability in

volume, unit value and total value for the major products

that are exported and for total exports were also computed.

These results are presented in Table IV-3, and they indicate

for the major products exported that the proceeds from rice

are relatively more unstable than the earnings obtained from

bauxite and sugar exports. The instability in the proceeds

from the exports of rice, bauxite and sugar were calculated

to be .065 for rice, and .019 for bauxite and sugar. Mean-

while the degree of instability in the value of Guyana

total export earnings was estimated to be .007. This in-

dicates that to some extent the fluctuations in the major

exported products were offsetting rather than reinforcing.

The results also indicate that the degree of instability in

the volume of Guyana's total exports is slightly greater than the







instability in the price (unit value) received for their

exports.



TABLE IV-3

INSTABILITY INDICIES FOR QUANTITY, UNIT VALUE AND TOTAL VALUE
OF GUYANA'S MAJOR EXPORT COM1IODITIES: 1956-73


AVERAGE ANNUAL DEVIATIONS FROM
COMMODITY GROWTH PATH (I -I* INDEX)

Rice:

Quantity .051
Unit Value .010
Total Value .065

Bauxite:

Quantity .014
Unit Value .015
Total Value .019

Sugar:

Quantity .015
Unit Value .021
Total Value .019

Total Exports:

Quantity .011
Unit Value .010
Total Value .007


Although the empirical results have in general failed to

substantiate the various explanations of the higher degree of

fluctuations in the export earnings of the less developed

countries, the problem associated with the fluctuations in

export earnings is nevertheless a real one. In an open

economy the adjustment process requires in the absence of

countercyclical monetary and/or fiscal policies, that domestic

spending as represented by nominal income, expand and contract

in accordance with the expansion and contraction of exports.







Consequently, it is reasoned for open economies, operating

under a system of fixed exchange rates, that there would be

domestic instability, as money income would vary "in the same

direction and more than proportional to the initial changes

in export proceeds" (MacBean, 1966, p. 26).

The hypothesis that instability in export earnings

causes instability in the economy was tested by Coppock

t1962) who correlated the instability index for national in-

come with the instability index for export earnings and from

which he obtained a very low correlation coefficient of .07.

When the countries in Coppock's study were categorized on the

basis of the magnitude of instability in their export earnings,

the resultant pattern indicated that one-third of the countries

which have the highest degree of instability in export earn-

ings, also have the highest degree of instability in national

money income. MacBean (1966) in his study also tested the

hypothesis that instability in export earnings causes in-

stability in domestic economic activity. Considering first

a sample of 35 LDC's and then 15 of the LDC's with relatively

high ratios of trade to GIP. MacBean obtained correlation

coefficientsof .015 and -.15 respectively, when the in-

stability index for GNP was regressed on the instability

index for export earnings. The estimated coefficients ob-

tained from the regressions were insignificantly different

from zero. A further analysis using time series date for

ten countries with very high ratios of trade to GNP, was used

by MacBean in order to examine the direction rather than the

magnitude of the fluctuations between export earnings and

GNP. The results indicate on a current-year basis that GNP






moved in the same direction as exports sixty-one times out

of ninety-nine. A further comparison of current year GNP

to exports lagged by one year, indicated from a total of

eighty-nine changes in export earnings that GNP moved in the

same direction only forty-four occasions.

For Guyana, we performed a test of the hypothesis that

excessive changes or fluctuations in export earnings causes

similar excessive changes or fluctuations in GNP. The fol-

lowing equation was estimated:

(4 7) IY = a + byIX + e

with the expectation that byj., should have a value greater

than one. Using annual data for the period 1952 to 1972, the

annual deviations from the growth path were computed and the

following results were obtained:

IY = .002 + 1.01 IX R2 = .38; D-W = 1.58
(1.62) (3.47)

The results (with t-statistics in parenthesis) indicate that

the coefficient for instability in export earnings, is signifi-

cantly different from zero. In addition the annual fluctua-

tions in export earnings around its growth path account for

only 38 percent of the annual fluctuations in GNP from the

growth path.

Induced Changes In Imports

The adjustment process entails not only the contraction

and expansion of income, in response to changes in exports.

It also entails in addition to contraction and expansion

of imports in response to the induced contraction and ex-

pansion in income (Polak, 1957-58, pp. 19-24; Prais, 1959-

1961). This requirement that imports also increase in







response to an increase in income, in conjunction with the

supposition that domestic investment in the LDC's is depen-

dent upon imported capital goods has led to the hypothesis

that fluctuations in export earnings cause similar fluctuations

in domestic investment (MacBean, 1966 p. 69).

MacBean (1966) in his book tested this hypothesis for

twenty LDC's. The countries ...'ere first ranked according to

their degree of export instability and then grouped into

thirds. It was found on this basis that the middle group

had the highest average degree of instability in investment.

Following this the instability index for investment was re-

gressed on the instability index for export earnings. The

correlation coefficient obtained from this regression was

non-signifianct at the 10 percent level of significance and

the fluctuations in export earnings explained only about 12

percent of the inter-country fluctuations in investment.

Usint time-series data for ten Latin American countries,

MacBean's results indicated for eight of the ten countries

that changes in capital goods imports moved in accordance

with the fluctuations in exports. However when the relation-

ship between changes in investment and the fluctuations in

export earnings was tested, "the supposed initiating force

of export fluctuations is significant for only three out of

eight" (p. 75).

We tested for Guyana the hypothesis that in an open

economy injections into the income stream arising from in-

creases in external transactions must if full adjustment







occurs within the economy, eventually all leak out of the

system in the form of imports. Using annual data for the

period 1955 through 1973, the following equation was

estimated:

(4 8) I = c3(X + K) + e

The corollary hypothesis that fluctuations in export

earnings cause similar fluctuations in investment will be

tested for the same period by the following equation:

(4 9) IV = a + blIX + u'

It is anticipated that in the case of equation (4-8) that

the coefficient, c, should have a .alue close to 1, if there

was full adjustmetn within the year. It is also anticiapted

in the case of equation (4-9) that if the fluctuations in

exports produce similar fluctuations in investment, that

the coefficient bI should be positive and ha'.'e a value close

to one.

The regression results for the two equations are

presented in Table IV-4. The coefficient,c,has a value of .7.

This indicates that within the current period imports adjusts

fairly rapidly to the changes in exports and net capital in-

flow. For equation (4-9) the coefficient bI is not signifi-

cantly different from zero. The null hypothesis in this

case cannot be rejected.

The Balance of Payments

The low values which have been obtained in the previous

section for the coefficentts, and b and the statistical

insignificance of bl, suggests that there might be some

mechanism in operation within the economy which tends to







TABLE IV-4

ESTIMfATES FOR THE CHANGES IN IMPORT EQUATION
AND THE INSTABILITY IN DOMESTIC INVESTMENT EQUATION


DEPENDENT


VARIABLE CONSTANT L(X + K) IX R D-W

.70 1.68
(5.29)

IV .02 .37 .07 1.87
(2.04) (1.09)


Notes: Figures in parenthesis = t-statistics; D-W = Durbin-
Watson statistic.


mitigate the monetary impulses that emanate from the balance

of payments and consequently attentuate the process of ad-

justment within the economy. This dampening of the adjust-

ment process could occur either through increases (decreases)

in the credit financed portion of the government budget deficit,

or alternatively by the banking system expanding (contracting)

bank credit at times when a decrease (increase) in exports and

net capital inflows causes a deficit (surplus) in the balance

of payments. The adoption of countercyclical monetary

policies will by maintaining a fairly constant level of

liquidity in the economy, tend to offset any change in domestic

expenditure and hence the change in income and imports which

would occur naturally as exports increase or decrease.

The excessive use of domestic financial policies in an

open economy, however poses severe problems for the mone-

tary authority as its impace on income and the demand for

money is only transient. This means that the excessive use






of domestic financial policies will only stimulate expendi-

tures on imports and thereby cause an outflow of foreign

assets.

The proposition that an increase in exports and the net

inflow of foreign capital improves the balance of payments,

whilst an increase in domestic assets hurts the balance of

payments will be tested by estimating the following equation



(4 0) B = + K) b AD + V

It is anticipated that the estimated coefficient for

A(X + K) will measure the proportion of the increase in

exports and net capital inflow which would leak out of the

economy during the year in the form of imports. It is

expected at the end of the year the effect of an increase in

exports and net capital inflow on the foreign assets of the

banking system, would be very small, if the proportion which

leaks our of the economy in the form of imports is large.

Conversely', its effect on the system's reserves will be

large, if a small proportion leaks out of the economy in the

form of imports. It is also anticipated that the coefficient,

bf, should have a value close to -1.0, if the expansion of

domestic credit leaks out in its entirety from the system.

If the equation (4-10) is estimated by ordinary least squares,

and, if in addition, domestic monetary policies were adopted

in order to sterlize (or reinforce) the monetary impulses which

originated from the balance of payments, the estimated

coefficient for D will be biased. The direction of the

bias which arises when there is a simultaneous relationship








between the change in reserves and domestic assets, can be

shown for the following very simple model: B = bAD + eV1 + u;

,D = 'to + xI B + hV2 + u'; where V1 represents an exogenous

influence on LD, with u and u' being the error terms. By

the following formula (Johnston, 1972, chap. 12; Kouri and

Porter, 1974, pp. 453-454; Porter, 1973, pp. 402-403)

( bct U)J 1 h2 h v + C2 + 2 2
plim (b b) = I(1 bcl)o / h2 2+ 2 u2)

2 2 '
where 2 = the variance of u; = variance of u and
u u
Mv2v2 = asymptotic variance of V Thus if the monetary

authority changes its holdings of domestic assets so that it

can offset the monetary impulses arising from the balance of

payments, the coefficient, c1, will have a negative sign and

the estimated coefficient b, will be biased towards -1. If on

the other hand the monetary authority reinforces the mone-

tary impusles arising from the balance of payments unto its

holdings of domestic assets, the coefficient, c1, will have

a positive sign, and the estimated coefficient, b, will be

biased towards zero. Consequently, in order to recognize

this possible simultaneous relationship between the balance

of payments and domestic assets, equation (3-9) and the

following policy reaction function:

(4 11) AD = alB + a2GD + v*

where

GD = government budget deficit

= error term

will be estimated by a two-stage procedure. The coefficient

for the variable GD is expected to be positive.






The results from estimating equation (4-10) first by

ordinary least squares and them from estimating equations

(4-10) and (4-11) by two-stage least squares are presented

below in Table IV-5. A plot of the actual and fitted values

of reserve flow, from equation (4-10) is shown in Figure IV-1.

The results are very interesting, on the one hand because

the estimated coefficient for the sum of exports and net

capital inflow is statistically significant at the 5 per-

cent level of significance when the balance of payments

equation is estimated by ordianry least squares. The

coefficient for the domestic credit variable is -.88. The

t-statistic for the hypothesis that the value of the coeffi-

cient for the domestic credit variable equal minus one is

1.5. On the other hand the coefficient for the changes in

the sum of exports and net capital inflow becomes insignifi-

cant when the balance of payments equation in conjunction

with the policy reaction function is estimated by two stage

least squares. Also the coefficient for domestic credit

variable is estimated to be -.64. The two variables in the

policy reaction function are also both statistically signifi-

cant.














TABLE IV-5

ESTIMATES FOR THE BALANCE
OF PAYMENTS EQUATION


DEPENDENT


METHOD OF


VARIALBE .(X4 + K) .,D B GD R2 D-W ESTIMATION

B .09 -.88 .87 1.27* OLSQ
(1.85) t-10.61)

B .07 -.64 TSLS
(1.28) (-4.69)

,D -.86 .11 TSLS
k-5.42) (4.66)


Note: Sample period : 1955-1973; Figures in parenthesis are
t-statistics; D-W = Durbin Watson Statistics; OLSQ =
oridnary least squares; TSLS = two stage least squares;
B = balance of payments; LD = changes in domestic
assets; iL(; + K) = changes in the sum of exports and
net capital inflow; GD = government's budget deficit.

*The Durbin-Watson statistic is in the uncertain region
at the 95 percent level.




















FIGURE IV-l


ko O 4 Lf0n %D r-- CO Om Co .-i4 CN
in Ln in in 0 '0 '% D 0 k 0 o 0 'k0 .D 'D0 '%O r- r- rI- r
4 r- I r-l i r- q r-4 ,-4 r-4 r-4 r-4 r-4 --4 ,-4 r-- r-4 r-4 ,-4 r-4


Actual (solid line) and predicted (dashed line) reserve
flo w.















Hotes



See Appendix A for a discussion on the various indices which
have been used to measure the degree of excessive changes
in income, exports, etc., along with the index which will be
used to measure the degree of product and geographic.

2The years before the attainment of political independence
in 1966 were characterized by political uncertainty, rioting,
looting, acts of arson and strikes.

3In the less developed countries it is often argued that most
of the imported goods is comprised of capital goods, since
most of the non-essential imports have been cut to a
minimum and also because these countries at their present
stage of economic development cannot produce in sufficient
quantities the machinery and other capital goods they need
in order to increase domestic investment.














CHAPTER V

ECONOMIC GROWTH, DOMESTIC FINANCIAL POLICIES
AND THE BALANCE OF PAYMENTS



In this Chapter the second major problem of the study,

namely the effects of economic growth and domestic financial

policies on the balance of payments will be examined accord-

ing to the new monetary approach to the balance of payments

and balance of payments adjustments. This new approach to

balance of payments theory begins by asking the following

question: What is the effect of a change in real income,

domestic price level, and where appropriate the effect of a

change in the interest rate on the demand for money? It

is then argued that those variables, which have a direct

association with the demand for money will similarly have

a direct effect on the balance of payments. Whilst those

variables which have an inverse relationship with the demand

for money will similarly have an adverse effect on the

balance of payments. Furthermore it is argued that if

domestic financial policies have no effect on income and

hence on the demand for money, the use of these policies will

not only hurt the balance of payments but it will in addition

cause an equiproportionate change in the country's foreign

assets (Johnson, 1972; Komiya, 1969; Mundell, 1968, pp.

126-129 and chap. 9). The balance of payments in an open

58







economy is therefore seen as the media through which the

public's desire for stock changes in asset portfolio is

satisfied in such a manner that in the long-run, equilibrium

is maintained in the monetary sector of the economy.

The money demand function is accordingly specified as:

(2 Ib) Md = kPy

since it is assumed that in the absence of a highly developed

capital market, money balances are held primarily for trans-

action purposes. The process of money creation is derived

from the banking system balance system sheet:

(2 2) MIs R + D

with changes in the money supply occurring through changes in

domestic and foreign assets:

(2 2a) dIls = dR + dD
dt dt dt

Equilibrium in the monetary sector requires that the demand

for money be equal to the money supply, thus:

(5 1) kP = P. + D

By expressing (2-2b) in logarithmic form and by differentiating

with respect to time, the following reserve flow equation is

derived:

(5 2)

r = (R/P. D)gr = g., + gk + gp (D/R +D)gd + e

where

g = d In R/dt = growth in foreign assets
,r
g = d In y/dt = growth in real income

g = d In k/dt = growth in the fraction of income that
people hold as money balances

g = d In p/dt = growth in domestic price level
I







gd = d In D/dt = growth in domestic assets.
According to equation (5-2) the expansion of domestic

assets whether it is to the general public or to the govern-

ment sector, is expected to cause a deterioration in the balance

of payments. A specific look at the effects of government's

budgetary policy on the balance of payments could be obtained

if it is assumed on the one hand that there is no lending with-

in the system to the private sector by the banking authorities

whilst on the other hand the banking authorities finance the

government budget deficit by credit creation. (Dornbusch, 1971;

McKinnon and Oates, 1966, pp. 13-17; Mundell, 1968, pp. 123-

124). Consequently in this system the growth in domestic

assets will be determined primarily by the growth in the

government's budget deficit, that is:

(5 3) g = b5gGD

where

gGD = d In GD/dt = growth in the government's budget
deficit

The substitution of equation (5-31 for gd in (5-2) leads to

the following reserve flow equation:

(5 4) r = (R,.'R +D)gr = gY, + gp + g b51D/R + D)gGD

On the basis of equation (5-2) and equation (5-4) it can

be seen that the balance of payments will improve with growth

in real income. The coefficient for g, indicates the effect

that a 1 percent increase in real income will have on the

demand for money and thereby on the balance of oavments. It

is expected that the value of the coefficient should be close

to unity.







A change in the price level is also expected to exert a

favorable effect on the flow of reserves, since an increase in

the price level will be reducing the real value of existing

money balances lead to an increase in the demand for nominal

money balances which will be satisfied by an inflow of re-

serv'.es. The effect on the flow of reserves could be adverse

if the increase in the price level reflects an increase in the

domestic price level relative to the world price level, as

this would tend to force people to increase their consumption

of imported goods relative to domestic goods.

The use of domestic financial policies to increase do-

mestic assets as a whole, and the credit financed portion of

the government budget deficit in particular, will if these

policies does not affect income and hence increase the demand

for money, only increase domestic expenditures on imported

goods and services and consequently generate an outflow of

reserves.

The estimated coefficients for g,, g.p and gGD should

have the following values: +1.0, +1.0, and -1.0. The

estimated coefficient for gd is also expected to have a value

of -1.0 if in the absence of economic growth, the increase in

liquidity mainly stimulated domestic expenditures on imported

goods and services in the long-run. Such a result would also

indicate that the monetary authority have no control over the

domestic money supply and that the monetary authority should

consequently control the expansion of domestic credit, for by

so doing they will be able to control the balance of payments

and thus the division of the country's assets between foreign




62


and domestic goods. This interpretation of the results re-

flects an underlying thesis of the monetary approach to the

balance of payments and balance of payments adjustment,

namely that the monetary impulses emanating from the balance

of payments are not offset by changes in domestic assets. It

is however plausible in the interest of internal stability on

the one hand that domestic assets could be adjusted in a manner

which is designed to offset the effects of disequilibrium in

the balance of payments on the money supply. On the other

hand domestic assets could be changed as suggested by Ola-

kanpo, in such a manner as to accentuate the effects of

balance of payments disequilibrium on the money supply. This

consequently means that the estimated coefficient of gd would

be biased in the direction of -1.0, if the monetary impulses

from the balance of payments are sterilized. The coefficient

.would be biased in the direction of zero, if domestic credit

contracts and expands according to the deficits and surpluses

in the balance of payments and thereby adhere to the gold-

standard "rules of the game."

In Guyana on the one hand it is quite unlikely in the

absence of a highly developed money market that changes in

domestic assets would compensate for the decreases or increases

in liquidity which results from a deficit or surplus in the

balance of payments. Also before the Central Bank was estab-

lished in 1965, there was no domestic central monetary autho-

rity in existence to deal with the problem of promoting and

maintaining monetary stability. Furthermore even with the

establishment of the Central Bank it is quite unlikely that

the monetary authority would be acting with the precision and







and accuracy that is needed to offset the monetary impulses

from the balance of payments and at the same time make sure

that the changes in domestic assets are always consistent

with the growth in economic activity. On the other hand it is

also quite unlikely that the Central Bank would want to in-

crease the degree of internal instability by varying domestic

assets directly in accordance with the surpluses and deficits

of the balance of payments. Also with mostof the commercial banks

being branches of the large multinational banks, it is quite

unlikely that the liquidity position of a branch bank in

anty one country should affect under normal circumstances its

lending policies in that country, since the Head Office can

shift funds from areas with surplus assets to areas experi-

encing a decline in their asset position. The possible simul-

taneous relationship between domestic assets and the balance

of payments, in spite of these reasons will nevertheless be

taken into account by the following policy reaction function:

(5 -5) d = (D/R +D)gd = b1(R + D)qr + b5gGD +

There have been four empirical studies (Bean, 1976;

Genburg, 1976; Guitian, 1976; Zecher, 1976) so far that have

examined the hypothesis that increases in real income and

the price level improve the balance of payments whilst in-

creases in domestic assets and the interest rate hurt the

balance of payments. Zecher in a study of Australia; Gen-

berg in a study of Sweden, and Bean in a study of Japan ob-

tained in general very good results when the money demand

function was substituted into the banking system balance-

sheet identity. They obtained in general coefficients which






were highly significant statistically and which yielded very

good fits between actual and predicted changes in reserve
-2
flows when quarterly data were used. Zecher obtained a R

of .89; whilst Genberg and Bean obtained, respectively R2's

of the following magnitude: .76 and .65. The study on Spain

by Guitian however yielded estimates of the variable in the

reserve flow equation that were with one exception all sta-

tistically insignificant. The only variable which was sig-

nificant was the domestic credit variable. Genberg in his

analysis also allowed for the possible simultaneous relation-

ship between changes in domestic assets and the balance of

payments by estimating the coefficients of the reserve flow

and the policy reaction equation according to a two-stage

procedure. The results using quarterly data, indicated

"that the specification of the Central Bank reaction function

is inadequate in that the government financing variable fails

to be significant." (Genberg, 1976, p. 323). However, when

annual data were used instead of quarterly data, the coeffi-

cient for the government budget deficit in the policy reaction

equation was positive and statistically significant.

For Guyana an initial test was made of the hypothesis

that the rate of inflation in the domestic economy is equal

to the rate of inflation in the world economy, that is the

coefficient in the following equation is equal to unity:

(5 6) g c(P/P)** + u*

where


g = The growth in domestic price level
P







(p/P)** = The rate of growth of inflation in the world

u* = Error term.

The result from estimating (5-6) by ordinary least squares

for the periods 1956 through 1973 is shown in the following

equation:

g = 1.00(P/P)** R2 = .99; D-W = 1.31*
p (259.5)
with the figures in parenthesis being the t-statistics. The

estimated coefficient for the rate of growth in the world's

rate of inflation corresponds to a priori reasoning, with the

R2 indicating that most of the variation in the domestic

price level are induced through changes in the average price

level in the United Kingdom, United States,and Canada.

Secondly, the money demand function (2-1) was estimated

with annual observations for the period 1955 to 1973 and the

following results were obtained:

gm = .60g, R2 = .98; D-W = 1.31*
(39.12)

where

gm = growth rate in nominal money balances.

g,, = growth rate in money income

*The Durbin-Watson statistic is in the uncertain region
at the 95 percent level.

Further substitution of the estimated money demand func-

tion into the banking system balance-sheet identity yielded

results which confirmed the monetary view that increases in

domestic assets and the financed portion of the government's

budget deficit, results in an outflow of foreign assets.

Whilst an increase in the domestic price level is associated






with an inflow of foreign assets. The coefficient for the

increase in the rate of economic growth has the correct sign

but it however turns out to be statistically insignificant.

The estimates for equation (5-2) and (5-4) are presented in

Table V-I. The relationship between actual and predicted re-

serve flows for equations (5-2) and (5-4) are also shown in

Figures V-1 and V-2.














4- J 0



-I-- -,-A
4 -JJ

rj







I


ri-,


mj


0 a-.





cr. coc


0
CP









S*-1



C

S0>


.0 CM
LT. 0

.-4
["' O .


I-


ri C*-


I I


%.D Lil





N C0
0- U-I

















FIGURE V-1


--4


%0 r-' cOi M C) o -i CNI r -r Ul f I' r- c o o r-1 re)
in ] ri in UO3 M. %OD \O k) D c r
c T o0 c0 cr M c'. M o C 1. 01 1 o 0 c' c


Actual (solid line) and predicted (dashed line) reserve flows,
domestic assets.


















FIGURE ,-2


%D r 0 aol'. O r-1 Cj n 'IT L" n 00 co0 O O r-I rN M
Ln Il Ln Ln %I D O '% '%D '%.0 %O % .o '%0 %.D r r r-N rN
oll M' G M' cN MT a,. 0'1 ON MT M' M' 0r. C31 Mt M Mc
l-l r-4 1-4 1-1 v-4 4 i - ,-q .-1 ,-4 ,- 4 -4 ,-q r-q -1

Actual (solid line) and predicted (dashed line) reserve flows,
Government Budget Deficit.














CHAPTER VI

SUMMARY OF STUDY

Introduction: (Chapter I)



This study empirically examines the monetary process of

adjustment in a small, open economy, Guyana, for the period

between 1955-1973. In keeping with the monetary approach to

balance of payments theory this process of adjustment is con-

sidered as occurring automatically, since according to Walras'

Law there is an undeniable linkage between the money market

and the goods market. This linkage between the money market

and the goods market and the subsequent initiation of an auto-

matic process of adjustment in response to a state of dis-

equilibrium in the monetary sector, provides a useful analytic

framework for the analysis of certain key issues. For example

the effects on the flow of international reserves resulting

from a change in the variables that determine the demand for

money, and a change in the domestic component of the money

supply. It also provides, via a simple version of the

quantity theory of money, a framework for analyzing the

effects of an increase in exports and net capital inflow on

the balance of payments, on the money supply, on income, and

imports. The linkage however poses for the short-run, the prob-





lem of choosing between two conflicting alternatives; on the

one hand there is the choice between either maintaining

equilibrium in the external sector and consequently accepting

some degree of internal economic instability. On the other

hand the choice is to use domestic monetary and/or fiscal

policy to maintain internal economic stability while there

is disequilibrium in the balance of payments. The empiri-

cal findings of Coppock (1962), MacBean (1966), and Massell

(1970), that the degree of instability in export earnings

among the developing countries is greater than the degree

of instability in export earnings among the developed

countries, in conjunction with the process of adjustment

according to the old version of the quantity theory of

money, has led to the expectation that the instability in

domestic economic activity is caused by the instability in

these countries export earnings. Furthermore, with their

imports consisting primarily of capital goods to be used

for investment purposes, it is suggested that the in-

stability in export earnings also causes instability in

domestic investment.

To be more specific, this study empircially examines,

on the basis of the economic experience of Guyana, the

monetary process of adjustment according to the quantity

theory of money, that is, it looks at the effect of an increase

in exports and net capital imports on the balance of payments,

money supply, money income, and imports. It also tests

the hypothesis that instability in domestic economic activity

is generated by instability in export earnings, and that the






instability in export earnings is caused by the high ratio

of primary products exported and the high degree of product

and geographic concentration. This study also tests the

hypothesis that an increase in real income and domestic

prices causes an inflow of foreign assets whilst an increase

in domestic assets and the credit financing of the government's

budget deficit causes an outflow of foreign assets.

The Theoretical Basis for the Study (Chapter II) Model A: The
Classical Adjustment Mechanism in an Open Economy.

The notion that an increase in exports and net inflow

of capital can by generating a surplus in the balance of

payments, subsequently induce, in the absence of neutralization

policies, an increase in the money supply, an increase in

domestic expenditures, an increase in money income, and an

increase in imports, can be outlined formally, by first

assuming the existence of a stable money demand function,

which depends upon money income, that is:

(6 1) Md = kY

where

Md = demand for money balances

Y = money income

Money income is defined as being equal to the product of

domestic prices and real income, that is Y = Py. It is also

assumed that the Cambridge k, which represents the proportion

of money income held in the form of money balances, is con-

stant and insensitive to changes in the interest rate.

Second, the process of money creation is defined on the

basis of the consolidated accounts of the banking system,






which requires according to accounting principles that the

total amount of monetary liabilities in the system be equal

to the total amount of assets within the system, that is:

(6 2) Ms = R + D

where

Ms = money supply

R = foreign assets

D = domestic assets

Consequently the changes in the money supply within the

system is determined by either the changes in foreign assets

and/or the changes in domestic assets. This relationship is

expressed as follows:

(6 2a) Als = AR + AD

where

AMls = change in the money supply

AR = changes in foreign assets

AD = change in domestic assets

Furthermore the changes in foreign assets is defined as being

equal to the balance of payments which is accordingly defined

as the following:

(6 3) A Bt I + K
t t t t t
where

AR = B = the balance of payments

Xt = exports

It = imports

K = net autonomous capital inflow






Imports is considered to be dependent upon inomce with, m,

representing the fraction of income that is expanded on

imports:

(6 4) It = mYt

Exports and net capital inflow is considered as being deter-

mined exogenously and is therefore specified as follows:

(6 5) t = X

(6 6) Kt = Ko

with X and Ko representing the annual values of exports and

net capital inflow.

In the next equation domestic expenditures is defined

as being a function of income and the state of liquidity in

the economy, that is:

(6 7) C= Y + c(fls Md)

where

C = domestic expenditures

On the basis of equation (6-7) one can see that an increase in

income and the existence of a state of excess liquidity will

increase domestic expenditures; whilst the existence of a

state of deficient liquidity will reduce domestic expenditures

and that consumer expenditures will equal income when there

is equilibrium in the monetary sector.

In the following equation, national income is defined

as consisting of the sum of domestic expenditures and the

balance on the current account:

(6 8) Y = C + X I

In order that we may look at the effects of an increase in

exports and net capital inflow on the various endogenous







variables within the system. It is furthermore assumed

that there is continuous equilibrium in the monetary sector.

Consequently by equating equations (6-1)and (6-2) we have the

condition for monetary equilibrium, which is as follows:

(6 9) kY = R + D

with k =

Following this we can express equation (6-9) and(6-3) in first-

difference form, that is:

(6 10) Yt = v(Rt + IDt)

and

(6 11) Rt = B = ;X AI + AK + Bt-1

By substituting equation (6-11)for ARt in equation (6-10) and

by assuming that the change in reserve and income is constant

in equilibrium (Polak, 1957-58; Polak and Argy, 1971). The

following long-run solution for income is obtained:

(6 12) LY = -1 (X + K)

Consequently, the solutions for the other endogenous

variables in the system are expressed as follows:

(6 13) I.Ms = 1 (X + K)

(6 14) AI = cL(X + K)

(6 15) B 1 ( + K) b1LD
mv 1

It is anticipated in this model that the estimated
1
coefficient, j, for the foreign trade multiplier in equation

(6-12) should be greater than unity. The estimated coefficient

-1, in equation (6-13)is expected to be positive with the
mv
coefficient indicating the proportion of the increase in

exports and net capital inflow which leaks out of the economy






in the form of imports. In the case of equation (6-14) it is

anticipated that the estiamted coefficient, c, should have a

value equal to one, if full adjustment occurs within the
1
current period. The estimated coefficient for in
mV
equation (6-15) is expected to be positive. The magnitude of

the coefficient reflects the proportion of the increase in

exports and net capital inflow which leaks out of the economy

in the form of imports. The estimated coefficient, bl, for

the domestic credit variable in equation (6-15) is expected

to be between -1 < b 0O. The value of b1 should approach -1,

if, according to the assumptions of the model, the increases

in domestic credit merely increased domestic expenditure on

imports and hence leak out in its entirety from the system.

If equation (6-15) is estimated by ordinary least squares

and if in addition the monetary authority neutralizes or re-

inforces the changes in its reserves unto its holdings of

domestic assets; then the estimated coefficient will be

biased. The nature of the bias which arises when equation

(6-15) is estimated by ordinary least squares, can be shown in

terms of the following very simple model: B = bliD + eV1 + u;

LD = o + culB + hV2 + u ; where V1 represents some other

exogenous influence on B; V2 also represents some other

exogenous influence on D with u and ul being the error terms.

A negative value for the estimated coefficient, ca1, indicates

that some sterilization of foreign assets have occurred, If

the monetary authorities reinforce the changes in foreign

assets unto its holdings of domestic assets, then the estimated

coefficient, ul, should be positive. The direction of the






asymptotic bias can be determined from the following formula:

(Johnston, 1972, Chap. 10; Kouri and Porter, 1974, pp. 453-454;

Porter, 1972, pp. 402-403)



plim (b bl)= 1(1 blco l) (h .22 + au, + 1 ou),


where

2 = the variance of u;
u

02 = variance of u';
u

MEv2 2 = asymptotic variance of v2-


Thus on the basis of this formulae one can see that when u' is

negative, the estimated coefficient b1 is biased towards -1 and

when al is positive that the coefficient will biased towards 0.

Consequently in order to recognize this possible simultaneous

relationship between the balance of payments and changes in

domestic assets, equation (6-15) in conjunction with the fol-

lowing equation:

(6 16) ID = c'lB + ':2GD

where

GD = government budget deficit

will be estimated by a two-stage procedure.

One of the consequences of this automatic process of

adjustment, is that in the absence of the use of counter-

cyclical domestic monetary and fiscal policies their is the

constant upsetting of internal stability whenever there is

disequilibrium in the external sector. For the developing

countries empirical studies by Coppock (1962), MacBean (1968)

and Massell (1970) seem to suggest that the principal factor






responsible for initiating the disequilibrium in the external

sector is the excessive changes or instability in the countries'

export earnings. It is further suggested that the causes of

the instability in export earnings lie in their specialization

in producing primary producing, their concentration upon too

few products for exports,and the concentration of their

trading relations to a limited number of countries (MacBean,

1966) that is:

(6 17) IX = a + bl PR + b2 CC + b3 GC

where

IX = instability in export earnings

PR = ratio of primary product exports to total exports

CC = commodity concentration index

GC = geographic concentration index.

It has also been suggested by MacBean (1966) that non-economic

factors such as war and politics within the less developed

countries may be more responsible for these countries in-

stability in export earnings. Following this, it is then

suggested that instability in domestic money income in the

less developed countries is generated by instability in their

export earnings, that is:

(6 18) IT = a + b IX

where

IY = instability in money income.

Furthermore with part of the adjustment process requiring

that there be a direct change in imports for every change in

exports, in conjunction wilt the assumption that most of the

imports is comprised of imported capital goods which are used







to increase domestic investment. It is then suggested on

this basis, that the instability in export earnings also

causes instability in total domestic investment, that is:

(6 -19) IV = a + bj IX

where

IV = instability in domestic investment.

Model B: The Adjustment Mechanism in an Open Economy Ac-
cordinq to the Monetary Approach to Balance of Payments Theory

In the monetary approach to balance of payments theory

and balance of payments adjustment, the emphasis in the

analysis has shifted from the factors that determine the

money supply, to those factors that determine the demand for

money. The demand for money as previously specified is

dependent upon the level of money income, that is

(6 1) 1ld = kY

It is furthermore assumed that in the long-run nominal in-

come will by definition be equal to the domestic price level

times the level of real output:

(6 la) Y = Py

where

P = domestic price level

I = real income

Hence by substituting equation (6-la) for money'income in

equation (6-1)we ha"e the following demand for money function:

(6 lc) Md = kPy

By further assuming that there is a state of continuous equi-

librium in the money market, we have the equilibrium condition,

that the demand for money is equal to the money supply, that is






(6 20) kPy = R + D

Following this the expression in equation (6-20) is expressed in

logarithmic form and then differentiated with respect to

time, from which the following reserve flow equation is

obtained (see Johnson, 1972):


(6-21) r =(- R)g + gk d + D
R+D r + dP R- )gd + e
where

gr = growth in foreign assets
r = (RIR+D)gr

g,, = growth in real income
I

gk = growth in the fraction of income people hold in
the form of money balances

gp = growth in price level

gd = growth in domestic assets.


In this new monetary approach to balance of payments

theory, increases in real income are assumed to be exogenously

determined by increases in the factors of production and

increases in productivity. The changes in domestic price

level, via the small country assumption are also assumed to be

exogenously determined by changes in the world price level.

The increases in the domestic credit variable represents the

only factor that the domestic monetary authority can control

and by so doing, control the flow of reserves.

A specific look at the effects on the flow of interna-

tional reserves resulting from the credit financing of the

government's annual budget deficit can be obtained by

assuming first that there is no lending by the banking






system to the private sector. Second, that the government

in order to finance its budget deficit, obtains credit

from the monetary authority. Consequently, the growth in

the government's budget deficit would determine the growth

of the domestic credit within the economy, that is

(6 22) qg = b5GD

where

gGD = growth in the government's budget deficit.

Hence by substituting equation (6-22) for gd in equation (6-21)

we obtain the following reserve flow equation:

R D
(6 23) r = ( RD-)gr = 91 + 9p + gk b5( RD) +
R+D p 5 R+D gGD + u

For equations (6-21) and (6-23) it is anticipated that the

coefficient for the income elasticity of demand for money would

be positive and that it would also be in the neighborhood of

unity. This direct relationship between growth in real in-

come and the balance of payments represents, on the one hand,

one of the major implications resulting from the new mone-

tary approach to balance of payments theory, which views a

surplus or deficit in the balance of apyments as a reflection

of the process of stock adjustment in the money market. On

the other hand, this result is at variance with the theme

which was once dominant in the early post World War II

period. The economic models in that era seem to suggest that

the increase in the rate of economic growth will only result

in the increase in imports and thereby cause the balance of

payments to deteriorate. (Johnson, 1954).






Changes in the domestic price variable are assumed

to exert a positive effect on the flow of reserves, since

an increase in the price level will reduce the holding of

real money balances. This consequently leads to an increase

in the desire for additional money balances. The subsequent

reduction in domestic expenditures in response to the in-

crease in the demand for money balances will generate an

inflow of reserves.

The coefficient, b5, for the government budget deficit

varialbe is expected to have the following value: -1 < b5

0. If the expansion of the government budget deficit does not

result in increasing the demand for money, by an amount,

which exceeds the increase in the money supply (Dornbusch,

1971). In the extreme case, the value of the coefficient

would tend to approach minus one, if the credit financing

of the government budget deficit merely stimulates domestic

expenditure on imports and hence leaks out of the economy in

its entirety.

It is also anticipated that the coefficient for the

variables, gp and (DID+R)gd should respectively be +1 and -1.

The coefficient for (DID+R)gd would however be biased in the

direction of -1, if the monetary authority attempt to neutralize

the monetary impulses arising from the balance of payments. It

would also be biased towards zero if the monetary authority

attempt to reinforce the changes in its holdings of net fo-

reign assets unto its holdings of domestic assets (Olakanpo,

1961). Consequently in order to recognize this simultaneous re-

lationship between the changes in foreign assets and domestic







assets, equation (6-21) in conjunction with the following

policy reaction function:

(6 24) d = (DID+R)gd = b (RIR+D)gr + b59G + V"

will be estimated by two-stage least squares

The Empirical Results (Chapters IV and V)

The estimates for equations (6-12), (6-13), (6-14), (6-15)

and (6-16) are reported in Table VI-1. In Table VI-2 the esti-

mates for (6-17), (6-18) and (6-19) are reported, whilst Table

VI-3 presents some instability indices for three of Guyana's

major export products. Table VI-4 records the estimates for

equations (6-21), (6-22) and (6-24). It also records the esti-

mated coefficients for the hypothesis that growth in money in-

come increases the demand for cash balances and that the rate of

growth in the domestic price level is determined by the aver-

age rate of growth in domestic prices in the United Kingdom,

the United States of America, and Canada.

The data used in the estimation of equations (6-12)

through (6-16) consists of annual data for the period between

1955-1973. A preliminary estimation of equations (6-12), (6-13)

and (6-14) by ordinary least squares yielded very low values

for the Durbin-Watson statistic which suggested that

residuals in these equations were serially correlated.

Consequently, these equations were transformed according to

the following scheme: Z = Zt /'Zt-l + 2 t2, where

o is the autoregressive coefficient. The placing of the

asterisk next to the regressions reported in Table I indicates

that the variable has been transformed according to the above

scheme.














II ( C

2 -0 *- .0

I W 0'
0 V
IVA 3 Vl VA
U 4J (U




r Q 0
4L II U 0







WOC
(I -r -




.-I ro co
*J 4J 0C
WU)
4C( 4-1
- 2 II D


< C



*H -H-i C 4CJ
04 U L)

il 0 E 0

SII U



0
f0 0 0
O
W E
r- UV



.- --H -i
4-1 (!j -C


4J- -4I
Vi a).Q
0fl 0 Q m

o0J II C---


U) Wu 3 U-7

000


r( C U) C'Q




a -U ri + .i
E 4 r(% XW
Si :3 4-1


cr- 4--1 <-i
U) C^i r-I E


C---


. CX

'--4
-00


ON

r-- o
o r,]






The results from testing the monetary process of ad-

justment according to the simple version of the quantity

theory of money, indicate that the process of adjustment

occurs fairly rapidly. In fact within a year the changes

in imports adjust almost completely to changes in the sum

of exports and net capital inflows. The estimated coef-

ficient for c, is .70. The estimated coefficients for changes

in the sum of exports and net capital inflow for equations

(6-13) and (6-15) indicate that a very great proportion of the

increase in exports and net capital inflow leak out of the

,,economy in the first year in the form of imports. Thus at

the end of the year the increase in exports and net capital

inflow have just a marginal effect on the country's net

foreign assets and the country's money supply. The coeffi-

cient for the domestic credit variable is -.88, when equation

(6-15) is estimated by ordianry least squares. The value of

the coefficient is -.64 when the equation is estimated by two-

stage-least squares. These results indicate that a signifi-

cant portion of the country's foreign assets are lost as a

result of the expansion of bank credit. The estimated

coefficient for the foreign trade multiplier is very low.

One of the consequences of this adjustment process is

that it entails the persistent upsetting of internal

economic conditions in order that equilibrium might be main-

tained in the external sector. For the developing countries

the excessive changes or instability in exports for various

reasons for example, a high ratio of primary product

exports to total exports, and a high degree of product and






geographic concentration have been identified through the

persistent disturbance of equilibrium in the balance of pay-

ments as the factor which causes instability or excessive

changes in domestic economic activity. TableVI-2 reports the

effects of the instability in export earnings on domestic

economic activity. It also reports the estimated coefficients

for the various factors which have been suggested to explain

the instability in export earnings. Table VI-3 presents insta-

b'ility indices for three of Guyana's major export products.

The results in Table VI-2 indicate that the instability

in Guyana's export earnings have contributed to the in-

stability in domestic money income. The estimated coeffi-

cinet for the instability in exports variable is 1.01. The

t-statistic indicate that the coefficient is highly signifi-

cant. The estimated coefficient for the instability index in

export earnings when regressed on the instability index for

domestic investment is .87. The t-statistic is however in-

significant. The results also fail to corroborate any of

the various notions which have been advanced to explain the

excessive degree of fluctuations in developing countries

export earnings. The only significant factor in equation

(6-17) is the dummy variable which is included as a means of

reflecting the political uncertainties and social unrest which

occurred between 1955-1965.

The results in Table VI-3 indicate that the export earnings

from rice are relatively more unstable than the earnings ac-

quired from exporting sugar and bauxite. It also indicates

that instability in the quantity of rice exported is greater





87









-i tIO co r- 0 (J U
r0r OU0
"] i n Ln" co It I E 3 --
S* C tC
cQ *-I O .0
0D r- -0 0'O
4-- --4 -I r, 0
'JJ- 0 -4
nr 3 >, 0- 1'-4
D 1 :.-, O II
o3 0 4 :-. 0

S-- re- rn o ---IE 0
.i 3 a II a.
4ll | 0 -l- 1

o.0 .' 0
In ( 1) 1-40
0 -0 I C O0


CL I I l 0 a C0
S-I 4- -4 I 0
Co- i-i 41) C 0

0 4- -CO
'- CO CD r-- r,
S r--- r-- i 0 1II O DO r
U O 0 r-n 41 0I 0-. -4 0 ('
I0 c+ 41J U, -I
+ *- I- C O'- u

U O. 3 .c ro C4J c, *-
14CO 0
4J .ill C U 4,
Srn ^--s co 4-1 U |-H 0

0 0o 0 o" I I r~ i 4J O O"
L U * C7 0 0 010
c' E- 2 I I + ~ ,
I U '- I :: > : (1 0o
0t- CL. 0 j :>** 42 ,-I .2
> C, E, Lr, I LC '

ZZ CC ) C a u
[> 1-- -- 4- O r -I -CL a
Uri > 0- 0 C --
a -2 2 IX c. o (N a 1 la > ) 41 .1


S- -Cm -< f
,. r- -- .. r H JU
Eci X ( CL-, 0 II E 0



c I o Q co C o- .1 .- -
>-* * 0 1C *-II
I --I- -- .- o --, u

>C II l -1 -i E C "
-- 0L *


S0 U lo '- C
E-: r rn r- cri 0
-. c -- -- r 4-J4 **-1 C
H rn c c 1i 0Or r. (t O'i u 0 C
U: C --1 0 1 m


Z .H . . ,- i 4 -- .- Ln
0 J I m 0 4o
.U .1 D-4- .4-J ,-.


-4 r 0 r CU -
C- cI( 0 i 0 0 U




Z I I II I U
1. X ~1- -- >- 0 -0 .D




a W> ri -r- O 0
C - -- 2
F-A 1 --,
CL < c CIN 4















TABLE VI-3

INSTABILITY IIDICES FOR QUANTITY, UNIT VALUE AND TOTAL VALUE
OF GUYANA'S MAJOR EXPORT COI4-IODITIES: 1956-1973

AVERAGE ANNUAL DEVIATIONS FROM
GROWTH PATH
COMMODITY (_I-I* IIDEX)


Rice:


Quantity
Unit Value
Total Value

Bauxite:

Quantity
Unit Value
Total Value

Sugar:

Quantity
Unit Value
Total Value

Total Exports:

Quant i tv
Unit Value
Total Value


.051
.010
.065


.014
.015
.019


.015
.021
.019


.011
.010
.007


Note: The instability' index (I-I*) was computed according to
the method used by Massell (1970).






than the instability in the unit value (price) of rice. Also

instability in the quantity of Guyana's total exports is

just slightly greater than the instability in the price which

Guyana's receives for its exports.

The results from testing the proposition associated

with the new monetary approach to balance of payments theory

are reported in Table VI-4. These results tend to substantiate

in general the various notions associated with the new mone-

tary approach to balance of payments theory. The notion that

the rate of inflation in an open economy under a system of

fixed exchange rate is determined by the rate of inflation

in the world, is substantiated by the experience in Guyana.

The estimated coefficient for this regression is 1.00. The

t-statistic indicate that the coefficient is significant.

The results also indicate that most of the variations in money

balances are explained by the variations in money income. The

estimation of the reserve flow equation indicates that one

of the principal factors generating an outflow of foreign

reserves in Guyana is the domestic credit variable. The

coefficient for this variable is -.86, when the reserve flow

equation is estimated in conjunction with the policy reaction

equation, by two-stage-least-squares. The corresponding t-

statistic for the test of the hypothesis that the value of

the coefficient., for the domestic credit variable is indeed

equal to -1 is .25. Thus one cannot reject this hypothesis.

The following t-statistics for a test of the hypothesis that

the value of the coefficient for gk and g is indeed equal to






S3
Z III CD Ul/

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S2z1* II I I I I I C7 C '7
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a" CL L *1H !*4 0 a .Q

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r-i- 0 -) II 4-Ji >--- C
^-1 L4 T a. mo 3 3 > D
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Q C4 Z





91
+1 and +1 respectively, are 1.32 and 1.85. The result also

indicatesthat the credit financing of the government's budget

deficit has been one of the factors responsible for the

country's loss of reserves. One of the disappointing aspect

of the results is that the growth rate in real income fails

to be statistically significant. Also the estimated coeffi-

cients in equation (6-24) are all insignificant.














CHAPTER VII

CONCLUSIONS



The purpose of this study has been to examine on the

basis of the economic experience of Guyana between 1955-1973,

the monetary process of adjustment in an open economy. This

objective is accomplished by looking at the process of ad-

justment which ensures equilibrium in the money market, ac-

cording to the monetary approach to balance of payments

theory. This study also examines on the basis of a simple

version of the quantity theory of money, whether the attempt

to maintain equilibrium in the external sector has resulted

in excessive changes or instability in domestic economic

activity. In particular it examines whether the excessive

changes in export earnings by constantly disturbing equilib-

rium in the balance of payments have resulted in excessive

changes or instability in money income and domestic invest-

ment. The study also looks at the reasons which have been

suggested to explain the instability in export earnings in

the less developed countries. Consequently, the main find-

ings of this study can be presented in terms of the following

three categories: (a) findings based on the simple quantity

theory of money; (b) findings on the relationship between

instability in export earnings and instability in domestic




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