A Note on External Adjustment
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A Note on External Adjustment
Credit and Capital Markets – Kredit und Kapital, Vol. 22 (1989), Iss. 3 : pp. 344–362
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D. K. Fausten, Clayton, Australia
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Abstract
A Note on External Adjustment
Exchange rates are determined by the interaction between the financial and real sectors of the economy. Alternative preoccupation with either assets markets or goods markets is unlikely to yield a meaningful explanation of balance of payments or exchange rate behaviour. In order to trace the implications of this interdependence for short-run adjustment behaviour, real assets are included in portfolios together with financial assets. Portfolio balance behaviour is animated by income as well as by relative yields, giving rise to the phenomenon of the “income-mobility” of international capital movements in addition to their “interest-mobility”. Disturbances initiate asset substitutions that are not confined to financial markets but that affect the real sector directly, and generate simultaneous and mutually compatible changes on current and on capital account. Any residual imbalances between the component accounts are eliminated by exchange rate changes which, consequently, do not display a stable relationship with movements in either component account.