Is Balance of Payments a Monetary Phenomenon: Doctrinal Aspects and Empirical Evidence from India

Purpose: The major objective of the study is to evaluate the applicability and efficacy of the monetary method by utilizing India's money supply and balance of payments account. Design/methodology/approach: Annual data f rom 1991 to 2024 is used in the research, particularly since LERMS was implemented in 1991. For stationary settings, this study used the Philips-Perron and Augmented Dickey-Fuller tests. The Autoregressive Distributed Lag-Error Correction Model (ARDL-ECM) was used in the study to analyze the short- and long-term relationships. Findings: The ARDL model test findings show a long-term relationship between BOP and independent variables such as capital outflows, money supply, and exchange rates. There was no short-term causation found using the ARDL-ECM model. Additionally, since LERMS, the analysis found no automatic restoration procedure in India's balance of payments. Therefore, this analysis concluded that the monetary method was less useful in resolving imbalances in India's balance of payments. Additionally, the study noted that in the setting of India's BOP, the function of monetary policy is ineffective. Research limitations/implications: For a developing country like India, this might not be a problem in the current environment. However, based on the Mundell-Flemings assignment rule, the study highly recommended Friedman's monetary rule for the long-term effectiveness of monetary policy in order to achieve external equilibrium. Originality/value: Testing the effectiveness of monetary policy in achieving external sector by comparing short-run effects with long-run effects is considered to be the uniqueness of this study.