CHAPTER ONE
1.1. HISTORICAL BACKGROUND OF THE STUDY
The monetary approach to balance of payments (MABP) has been a dominant view in the International Monetary Economics, particularly; the theory is believed to' have a long historical background. Which can be traced back to the writings of the classical economists who conceived a system of integrated world capital market and mobility? It is linked to the origin of balance of payments theory in the work of David Hume, and more specifically, to this theory of price-specie-flow mechanism (Johnson, 1976). While criticizing the objective of mercantilism in accumulating precious metals, David Hume pointed out that the amount of money in a country would be adjusted automatically to the demand for it. In Hume's analysis, the process in which this adjustment takes place is through surpluses and adjustment deficits in the balance of payments brought about by changes in relative national money price levels. However, while drawing heavily from Humes theory of balance of payments, and this analysis of price-specie flow mechanism, the monetary approach places emphasis' on monetary considerations in the interpretation of external balance problems rather than on changes in relative national price levels (Dornhusch and Fischer, 1990, 764).
The balance of payments account in Nigeria since political independence has undergone periods of boom and doom at different stages. The period of boom has been short-lived and is essentially attributed to the unprecedented increase in the oil price of 1973 - 1974. Apart from this period, Nigeria has continued to experience serious problems In the balance of payments position and the problem became severe in the early 1980' s. From an overall surplus of about N2A billion in 1980 in Nigeria's balance of payments, the country recorded a persistent deficits of (N3 billion), (Nl.4billion) and (0.3billion) in 1981, 1982 and 1983 respectively.
The internal factors that are responsible for the adverse balance of payments position inNigeria include among other things, excessive demand for foreign products, heavy reliance base, political instability and structural rigidities in the domestic production process. The weaknesses, in the domestic macroeconomic policies have tended to the problem. Moreover, the trade and exchange rate policies pursued during the oil boom era of 1970s and early 1980s failed to generate the required incentives for earning or saving foreign exchange. Rather, they resulted in several macroeconomic distortions and entrenched import-oriented consumption and production patterns in Nigeria which widened the trade gap.
With respect to the monetary approach to balance of payment under a fixed exchange rate regime, this studies focused on the influence of changes or growth in determination of money demand as well as domestic component of money supply in changes or growth in external reserves.
The: results of these studies in most cases support the propositions of the monetary approach. For instance, Courechence and Youssefs (1967) study of the relative influence of imports and money supply on the demand foreign exchange reserves for a group of nine countries(Switzerland, Netherlands, Denmark, Sweden, Germany, Belgium, Italy, Japan and Australia) indicates that money supply is superior to the level of imports in determining the level of foreign reserves. Their empirical 'results indicate that money supply and long-term interest rate are arguments in the demand function for individual country's foreign exchanges reserves. From their study, Courchence and Youssef conclude that "the application of the concepts of monetary theory to the field of international payments can be very fruitful.
The basic concepts of the monetary approach can be found in the works of Frenkel and Johnson (1976), Musa (1974, 1976), Johnson (1958, 1972, 1976a, 1976b and 1977). Copppock (1978), Melvin (1984) and Uddin (1985). Other contributions to the development of the monetary approach to balance of payments (MABP) theory include. Mundell (1968), Dornbusch (1971), Tsiang (1977) and Bilson (1978). The central argument of the MABP is that external balance problems are essentially (but not exclusively) Monetary in nature. As such, the proponents of the monetary approach argue that the:
"Balance of payments problems in a monetary world should
be analysed by models that explicitly specify monetary behaviour
and integrate it with the real economy rather than by models
that concentrate on real relationships and real monetary behaviour as a residuance of real behaviour".
1.2 INTRODUCTION
Monetary approach exerts its influence on the economy through changes in money supply and interest rates. These variables also tend. to effect the position of the balance of payments at any point in time. Monetary approach deals only with the ultimate effect and not with the channels through which this effect occurs. Thus monetary approach is essential for sensible discussion of the balance of payments and that the money demand function and money supply process should play a central role in the balance of payments analysis, particularly for the long-run.
The monetary approach to the balance of payments dates back to David Hume's refutation by use of the analysis of the price-specie-flow mechanism of the mercantilist belief that a country could achieve a persistent external surplus by import-substitution and export promotion approach.
The reveal of the monetary approach was brought about through the growing reluctance of countries to resort to either-devaluation or appreciation of their domestic currencies to current external imbalance, together with the imposition of restraints on the ability of countries to use exchange controls and trade interventions respectively through the restoration of European currency convertibility in 1958 and successive common markets among 'countries. The restoration of the monetary-theoretic aspects of the balance of payments and included in the work of Hahn (1959), Kemp (1970) and Khan and Argy (1971).
With the continuous application of monetary approach in Nigeria coupled with the other economic policies aimed at solving the imbalance in the international trading and payments position, Nigeria has not been able to achieve viability and precision in its external reserve position. Among these studies are Gray (1963) which examined the effects of credit creation for investment purposes on the balance of payment for Nigeria's first- National Development Plan Period, Olofin et al 1986 which examined the effects of devaluation on the macro economy, Omobitan (1995), which concentrated on the study of the trends, issues and determinants of the balance of payments.
1.3 STATEMENT OF THE PROBLEM
'The monetary approach to the balance of payments has been related to the asset market 'approach. This analysis changes in the balance of payments position in terms of stock adjustments in the money market in which the supply and demand for money balances are eventually willingly held.
Since the global economic crisis of the 1980s, many developing countries like Nigeria has been grappling with numerous economic problems. Such problems include growing unemployment, unsustainable fiscal deficits, high inflationary pressures, mounting debt burden, adverse balance of payments, under-utilization of capacity and exchange rate misalignment. In Nigeria, the adverse balance of payments which could be attributed to a number of factor (both internal and external), reflect the deep-seated problems in the economy.
.