Abstract

Balance-of-Payments Equilibrium and the Trade Cycle

In the light of the unsatisfactory experience with parity changes in the present international monetary system and the undesirable consequences of persistent disequilibrium of the balance of payments, a clear definition of the structure of the balance of payments is indispensable. In this connection, however, very important short-term factors such as the influences deriving from trade cycle impulses are often neglected. It would therefore seem to be necessary to include this aspect in the debate on balance-of-payments theory and policy. In this treatise an attempt is undertaken to analyse the influence of trade cycle fluctuations on the balance of payments and the consequences for foreign trade and, in particular, exchange-rate policy. However, it is limited to aspects affecting the principles and touches upon empirical matters only here and there. First, the cyclical changes in the net positions of the component parts of the balance of payments along the time path of the trade cycle are considered. The impact of trade cycle fluctuations on the balance of payments is that, in principle, all three component 'balances on current account (visible balance, invisible balance, transfer balance) tend to become more favourable in a similar manner, though to a differing absolute degree, in phases of relatively weak overall economic activity, but to become more unfavourable in phases of relatively great activity. The balance of payments in the sense of a “reduced basic balance” consequently tends towards surpluses induced by the trade cycle in the former case and deficits in the latter case. As a result it is necessary for the balance-of-payments diagnostician to isolate the trade-cycle influences on the balance of payments and to reach a “phase-related”judgment. In this way it becomes possible to obtain a cyclically neutral picture of the foreign trade situation and of the structure of the balance of payments at any given time, which in turn constitutes a decisive criterion for possible measures of balance-of-payments and, in particular, exchange-rate policy. A cyclical adjustment of the balance of payments is important so that an exchange-rate policy decision oriented to the current balance-of-payments situation is not misguided with regard to the scope and timing of a necessary correction. An example of a balance of payments greatly distorted by the trade cycle and of the danger of a consequent misjudgment is the case of the Federal Republic of Germany in 1970. It becomes clear how a phase-related balance-of-payments diagnosis can contribute to better timing of parity adjustments and help to reduce the extent of national disturbances and international distortions.