Stochastic and Nonstochastic Disequilibria

All payments disequilibria may be classified as either stochastic or nonstochsatic.

Stochastic disequilibria include reversible seasonal or cyclical variations of the balance of payments, as well as imbalances arising from simple random disturbances in the economic environment.

That is, from such temporary and non-repetitive upsets as natural catastrophes, civil disturbances, or 'honest policy mistakes.'

Stochastic disturbances are also said to have a long-run average value of zero.

Nonstochastic disequilibria are those arising from disturbances of a more lasting nature, such as persistent monetary inflation or deflation in individual countries (monetary disturbances).

In technical terms, such disequilibria have a nonzero expected value.

In cases of nonstochastic disequilibria, real adjustment is clearly called for. Financing in such circumstances merely postpones the inevitable--- and worse, actually tends to increase the total cost of the real adjustments that will eventually be required.

The longer a disequilibrium persists, the more it tends to distort patterns of capital investment in individual economies and, consequently, the more it tends to add to the stock of plant and equipment that, becoming redundant, will ultimately have to be written off.

Stochastic disequilibria, on the other hand, clearly do not require a reallocation of real resources.

The gap between demand and supply in the foreign exchange market is by definition temporary and non-repetitive.

To force real adjustment in such circumstances is to impose unnecessary transitional adjustment costs on the world economy.

Global economic welfare will actually benefit to the extent that such disequilibria are handled simply by a policy of financing.

Where stochastic disequilibria are concerned, therefore, financing is a substitute for adjustment. This is the first of the two respects in which liquidity is important to the monetary order.

If reserves are too scarce, countries will be compelled to adjust needlessly; by the same token, if reserves are too abundant, they will be tempted to postpone adjustment needlessly.

Either way, adjustment costs will be greater than the minimum which constitutes the efficiency objective.

At the same time, for nonstochastic disequilibria, financing and adjustment should be considered as complements rather than rivals.

This is the second of the two respects in which liquidity is important to the monetary order. The ability to finance determines a government's effective range of choice among adjustment alternatives.

Some adjustment policies work much more rapidly than others, and frequently a slower-working policy will be the preferred alternative on welfare grounds.

The optimal supply (and rate of growth) of reserves, therefore, may be defined as the one that ensures the most efficient mix of financing and adjustment in both of these respects--- the one, in short, that optimizes the global adjustment process.

Unhappily, there is no easy way to go about actually identifying such a reserve optimum. Partly this is because of the uncertainty and unpredictability of adjustment costs already referred to.

Partly, as well, it is due to the inherent practical difficulty of trying to distinguish between stochastic and nonstochastic disequilibria among real-world payments disturbances.

Rules and conventions to deal with the liquidity problem are no easier to design than those for dealing with the adjustment problem.

This is an equally tough challenge to the monetary order.

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