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Various approaches

  • J. A. H. de Beaufort Wijnholds
Part of the Publication of the Netherlands Institute of Bankers and Stock Brokers book series (PIBS, volume 31)

Abstract

The present chapter reviews various approaches - old and new - toward assessing the need for reserves as developed since 1960. What is common to the approaches discussed here is that they aim at finding operationally useful indicators of the need for and the adequacy of international reserves. Pure analysis of the reserve need problem in which the operational aspect is a secondary consideration, is treated in chapter 6.l

Keywords

International Reserve Capital Movement International Liquidity International Transaction International Monetary System 
These keywords were added by machine and not by the authors. This process is experimental and the keywords may be updated as the learning algorithm improves.

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References

  1. 2.
    Robert Triffin, Gold and the Dollar Crisis, New Haven, 1960. This book reproduced to a large extent the contents of two articles by Triffin published in the Banca Nazionale del Lavoro Quarterly Review, viz. “The Return to Convertibility: or Convertibility and the Morning After” (March 1959) and “Tomorrow’s Convertibility: Aim and Means of International Policy” (June 1959). In earlier publications Triffin had already presented some of the same arguments as those given in his book of 1960; cf. his book Europe and the Money Muddle, New Haven, 1957, and his Wicksell Lecture for 1958, The Future of the European Payments System, Stockholm, 1958.Google Scholar
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    The main reason for his choice of the reserves/imports ratio as a reserve need indicator was the availability of ready-made calculations of this measure in the IMF study International Reserves and Liquidity (discussed in section ν of chapter 4). The second reason was that this ratio was the “most popularized in all postwar discussions of the subject, and that monetary authorities in many countries are apt to think today of reserve adequacy in these terms” (Gold and the Dollar Crisis, p. 36).Google Scholar
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    Cf. Fritz Machlup, “Further Reflections on the Demand for Foreign Reserves”, (originally written in 1962) in his collected essays, International Monetary Economics, London, 1966, p. 262 (British edition). Machlup notes that: “The ratio of official gold and foreign-exchange holdings of all countries to their imports was 49 per cent in 1960; this was much less than the 117 per cent in 1938, but much more than the 21 per cent in 1913. Incidentally this “drastic decline” and “sharp increase”, depending on the year with which the comparison is made, teaches again the old lesson that one must not trust trends and rates of change derived from arbitrarily chosen base years”.Google Scholar
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    Cf. Fritz Machlup, Plans for Reform of the International Monetary System (originally published in 1962 in the Princeton series), in the collection of essays, International Monetary Economics, London, 1966, p. 296. See also Fritz Machlup, “Liquidité Internationale et Nationale”, Bulletin d’Information et de Documentation, Banque Nationale de Belgique, February 1962 (also reproduced in International Monetary Economics).Google Scholar
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    Baumöl found that “…. the square root formula implies that demand for cash rises less than in proportion with the volume of transactions, so that there are, in effect, economies of large scale in the use of cash.” Cf. William J. Baumöl, “The Transactions Demand for Cash: An Inventory Theoretic Approach”, Quarterly Journal of Economics, November 1952, pp. 550, 551 and 556. The same view was expressed by Professor Bent Hansen in his Central Bank of Egypt Lectures on International Liquidity, Cairo, 1962 (p. 8). More recent theoretical studies which also suggest the existence of economies of scale in reserve holding are: Julio H.G. Olivera, “A Note on the Optimal Rate of Growth of International Reserves”, Journal of Political Economy, March/April 1969; E. Streissler, “A Stochastic Model of International Reserve Requirements During Growth of World Trade”, Zeitschrift für Nationalökonomie, December 1969; Julio H.G. Olivera, “The Square-Root Law of Precautionary Reserves”, Journal of Political Economy, September/October 1971; and Lawrence H. Officer, “The Demand for International Liquidity: A Test of the Square-Root Law”, Journal of Money, Credit and Banking, August 1976.Google Scholar
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    Italics added. Cf. IMF, Annual Report, 1964, p. 29.Google Scholar
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    The relation between the balance of payments adjustment process and the need for reserves is discussed in section vi Of this chapter.Google Scholar
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    IMF, Annual Report, 1964, p. 30.Google Scholar
  25. 1.
    In this connection the efforts of Mr. Høst-Madsen of the IMF to arrive at figures for the payments imbalance for the world as a whole, especially with regard to solving the problem of asymmetries between balance of payments surpluses and deficits may be mentioned. Cf. Poul Høst-Madsen, “Asymmetries Between Payments Surpluses and Deficits”, IMF Staff Papers, July 1962, and “Measurement of Imbalance in World Payments 1947–58”, IMF Staff Papers, November 1962. His contribution toward a shift in emphasis to examining the needed growth of reserves rather than the absolute level of reserve needs has been recognized by Fleming; cf. J. Marcus Fleming, Toward Assessing the Need for International Reserves, Essays in International Finance No. 58, Princeton, February 1967, p. 12 n.Google Scholar
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    Communiqué of Ministers and Governors of the Group of Ten of October 2, 1963. Members of the study group were the Deputies of the Ministers and Governors.Google Scholar
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    Cf. Ministerial Statement of the Group of Ten and Annex Prepared by Deputies, August 1964, par. 24 (reproduced in Robert V. Roosa, Monetary Reform for the World Economy, New York, 1965).Google Scholar
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    Cf. Fritz Machlup and Burton G. Malkiel (editors), International Monetary Arrangements: The Problem of Choice, Report on the Deliberations of an International Study Group of 32 Economists, Princeton, 1964, p. 33.Google Scholar
  29. 4.
    Cf. Rudolf R. Rhomberg, “Trends in Payments Imbalances 1952–64”, IMF Staff Papers, November 1966, and The Need for Reserves: An Exploratory Paper, Paper presented by the Fund staff in January 1966 (reproduced in International Reserves: Needs and Availability). In its study the Fund staff noted, inter alia, that the stock of reserves and the growth rate of reserves are to some extent substitutes for each other (for the theoretical foundation of this view, see section ii of chapter 6 below). For this reason it considered it desirable to analyse the need for reserves with regard to both the “stock approach” and the “flow approach”. The Fund staff contended that “in absence of other information” it would be best to assume that payments imbalances will tend to increase proportionally with the volume of international transactions, with imports forming a rough measure of the latter. Taking the absolute amount of the balance of payments disequilibrium of each country, without regard to sign, the staff found an average annual increase of about 6 per cent for the period 1952–64, which is of the same magnitude as the average growth rate of world trade in that period.Google Scholar
  30. 5.
    IMF, Annual Report, 1966, p. 14.Google Scholar
  31. 1.
    Cf. Quantitative Criteria for the Assessment of Reserve Needs, Paper prepared by the Fund staff in June 1969 (reproduced in International Reserves: Needs and Availability). The base period chosen was 1954–68, as it is long enough to analyse trends and because the global reserve situation was deemed to have been broadly satisfactory during this period (except perhaps for the years 1965–68).Google Scholar
  32. 2.
    The Fund staff noted that imports are an imperfect indicator of these magnitudes but “provide the most useful generally available measure” of them (ibid. p. 471).Google Scholar
  33. 3.
    The “normal” level was taken to be the average ratio during the period 1954–68.Google Scholar
  34. 1.
    More fundamental problems associated with this approach are discussed at the end of this section.Google Scholar
  35. 2.
    International Reserves: Needs and Availability, p. 466. A broad outline of a global model which would permit the quantification of the effects of changes in global reserves has been drawn up by Rhomberg; cf. section iv of chapter 6 below.Google Scholar
  36. 3.
    Cf. Proposal by the Managing Director in International Reserves: Needs and Availability.Google Scholar
  37. 4.
    The Need for Reserves: Calculation for the Period 1973 to 1977, unpublished staff memorandum of May 1972. See also section ν of chapter 6 below.Google Scholar
  38. 1.
    Payments imbalances were calculated by adding the balance of payments deficits as well as surpluses of sixty countries. The calculation used in the Fund’s 1964 Annual Report (see p. 67 above) was based on an aggregation of deficits only. The difference in method of calculation seems to be due to the fact that asymmetries in total balance of payments surpluses and deficits (other than those arising from changes in the world stock of monetary gold, and, since 1970, from the allocation of SDR’s) have been increasing rapidly in size since the late sixties. Such asymmetries are due mainly to the investment of official reserves on the Eurocurrency market, since such investments are entered as official reserve transactions of the country of the central bank which places funds in the market, whereas they appear as transactions of commercial banks in the balance of payments of the country receiving the funds.Google Scholar
  39. 1.
    See p. 68 above.Google Scholar
  40. 2.
    IMF, Annual Report, 1969, pp. 25, 26.Google Scholar
  41. 3.
    Robert Clower and Richard Lipsey, “The Present State of International Liquidity Theory”, American Economic Review, May 1968, p. 593.Google Scholar
  42. 4.
    Cf. J.J. Polak, “Money: National and International” in International Reserves: Needs and Availability, p. 512.Google Scholar
  43. 5.
    John Williamson, “Surveys in Applied Economics: International Liquidity”, Economic Journal, September 1973, p. 697.Google Scholar
  44. 6.
    John H. Makin, “Exchange Rate Flexibility and the Demand for International Reserves”, Weltwirtschaftliches Archiv, No. 2, 1974.Google Scholar
  45. 7.
    Based on the so-called square root law as developed by Olivera; cf. note 3 on p. 64 above.Google Scholar
  46. 2.
    Cf. Weir M. Brown, The External Liquidity of an Advanced Country, Studies in International Finance No. 14, Princeton, 1964.Google Scholar
  47. 3.
    The problem of the wide swings in the sum of payments imbalances which render trend calculations of little significance was referred to on p. 69 above.Google Scholar
  48. 4.
    Cf. Quantitative Criteria for the Assessment of Reserve Needs.Google Scholar
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    Walter S. Salant, “Practical Techniques for Assessing the Need for World Reserves”, in International Reserves: Needs and Availability, p. 292.Google Scholar
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    Cf. Leland B. Yeager, “The Misconceived Problem of International Liquidity”, Journal of Finance, September 1959.Google Scholar
  51. 7.
    Cf. The External Liquidity of An Advanced Country, pp. 22–23.Google Scholar
  52. 2a.
    Cf. Egon Sohmen, “General Reserve Supplementation: Some Central Issues”, in IMF, International Reserves: Needs and Availability, especially pp. 29,Google Scholar
  53. 2a.
    Cf. Egon Sohmen, “General Reserve Supplementation: Some Central Issues”, in IMF, International Reserves: Needs and Availability, especially 30.Google Scholar
  54. 1.
    Group of Ten, Ministerial Statement and Annex Prepared by Deputies, August 1964, par. 34.Google Scholar
  55. 2.
    Cf. Group of Ten, Report of the Study Group on the Creation of Reserve Assets, August 1965, par. 8.Google Scholar
  56. 3.
    Cf. Group of Ten, Communiqué of Ministers and Governors and Report of Deputies, July 1966, par. 34.Google Scholar
  57. 4.
    IMF, Annual Report, 1965, p. 16.Google Scholar
  58. 5a.
    William Fellner, “Rules of the Game: Vintage 1966”, in William Fellner, Fritz Machlup, Robert Triffin and Eleven Others, Maintaining and Restoring Balance in International Payments, Princeton, 1966, pp. 13Google Scholar
  59. 5b.
    William Fellner, “Rules of the Game: Vintage 1966”, in William Fellner, Fritz Machlup, Robert Triffin and Eleven Others, Maintaining and Restoring Balance in International Payments, Princeton, 1966, and 16.Google Scholar
  60. 6.
    Cf. Fritz Machlup, “The Need for Monetary Reserves”, Banca Nazionale del Lavoro Quarterly Review, September 1966 (Reprints in International Finance No. 5, Princeton, 1966).Google Scholar
  61. 7.
    Ibid., p. 26 of the reprint.Google Scholar
  62. 1.
    Ibid., p. 29.Google Scholar
  63. 2.
    Machlup (“The Need for Monetary Reserves”, p. 4) objects to the use of the term “demand for reserves”, because it implies an offer for something in exchange for the object demanded and therefore involves a price. It can be argued, however, that the price involved in the demand for reserves is the opportunity cost of holding reserves. The price is therefore the return foregone on investment of the resources that would have been available if there had been no accumulation of reserves.Google Scholar
  64. 3.
    There exists considerable confusion with regard to the terms “demand” and “need” for reserves in the literature. These concepts are briefly explained in the Introduction and more fully in section i of chapter 9 of this study.Google Scholar
  65. 1.
    Cf. section iii of chapter 4 above. Williamson (Economic Journal, September 1973, p. 694) has observed with regard to Machlup’s views that “It is paradoxical that the economist who so vigorously resisted the suggestion that businessmen are satisficers should have so readily assumed that central bankers are ! “Google Scholar
  66. 2.
    “The Need for Monetary Reserves”, p. 21.Google Scholar
  67. 3.
    Robert Clower and Richard Lipsey, “The Present State of International Liquidity Theory”, American Economic Review, May 1968.Google Scholar
  68. 4.
    Ibid., p. 594.Google Scholar
  69. 1.
    Ibid., p. 595.Google Scholar
  70. 2.
    M. June Flanders, “International Liquidity is Always Inadequate”, Kyklos, No. 3, 1969.Google Scholar
  71. 3.
    Flanders states (p. 523, note 8) that this conclusion is the complement of Machlup’s conclusion that: “There is no sense.… in which it can be said that the world total of monetary reserves is inadequate”. (“The Need for Monetary Reserves”, p. 33). For a later publication by Flanders, dealing with the determinants of the demand for reserves, see the Appendix.Google Scholar
  72. 1.
    See p. 24 above.Google Scholar
  73. 2.
    See p. 62 above.Google Scholar
  74. 3.
    Oscar L. Altman, “Professor Triffin on International Liquidity and the Role of the Fund”, IMF Staff Papers, May 1961, pp. 177–178. Altman concluded that these symptoms were absent during the years 1957–59 although the growth of reserves was much smaller than that of world trade during that period.Google Scholar
  75. 1.
    Robert Triffin, Gold and the Dollar Crisis, New Haven, 1960, p. 151. See also Leland B. Yeager, “The Triffin Plan: Diagnosis, Remedy and Alternatives”, Kyklos, No. 3, 1961, reproduced in Herbert G. Grubel (ed.), World Monetary Reform, Stanford, 1963; cf. p. 169.Google Scholar
  76. 2.
    Cf. Roy Harrod, “A Plan for Increasing Liquidity: A Critique”, Economica, May 1961, reproduced in World Monetary Reform (see especially p. 118).Google Scholar
  77. 3.
    Roy Harrod, “Liquidity”, in World Monetary Reform, p. 208.Google Scholar
  78. 4.
    Cf. Roy Harrod, “The Dollar Problem and the Gold Question”, in Seymour E. Harris (ed.), The Dollar in Crisis, New York, 1961 (especially pp. 47–48).Google Scholar
  79. 5.
    Harry G. Johnson, “International Liquidity: Problems and Plans”, Malayan Economic Review, April 1962, reproduced in World Monetary Reform; op. cit. p. 373.Google Scholar
  80. 1.
    Cf. Report of the Nederlandsche Bank for the year 1960, p. 12.Google Scholar
  81. 2.
    Cf. Report of the Nederlandsche Bank for the year 1964, p. 18.Google Scholar
  82. 3.
    Group of Ten, Ministerial Statement and Annex prepared by Deputies, Paris, 1964, par. 24.Google Scholar
  83. 4.
    Group of Ten, Report of the Study Group on the Creation of Reserve Assets, Paris, 1965, par. 10.Google Scholar
  84. 5.
    Cf. Gottfried Haberler, Money in the International Economy, London, 1965, pp. 40–41.Google Scholar
  85. 1.
    IMF, Annual Report, 1965, p. 14.Google Scholar
  86. 2.
    IMF, Annual Report, 1966, p. 10. For a similar view see Milton Gilbert, Problems of the International Monetary System, Essays in International Finance No. 53, Princeton, April 1966, pp. 19–20. Gilbert also mentioned exchange instability and payments restrictions as the most likely symptoms of a shortage of reserves and added a third symptom, viz. deteriorating standards for the use of official borrowing facilities.Google Scholar
  87. 3.
    IMF, Annual Report, 1966, p. 12.Google Scholar
  88. 4.
    Report of the Nederlandsche Bank for the year 1965, p. 26.Google Scholar
  89. 5.
    See p. 80 above.Google Scholar
  90. 1.
    IMF, Annual Report, 1969, p. 26.Google Scholar
  91. 2.
    Cf. Proposal by the Managing Director in International Reserves: Needs and Availability.Google Scholar
  92. 3.
    Cf. Victor Argy, Comments on paper by Ahtiala, in International Reserves: Needs and Availability.Google Scholar
  93. 1.
    Cf. John Williamson, “Surveys in Applied Economics: International Liquidity”, Economic Journal, September 1973, p. 733.Google Scholar
  94. 2.
    Cf. Robert A. Mundell, International Economics, London, 1968, chapter 13.Google Scholar
  95. 1.
    Cf. Stephen Marris, The Bürgenstock Communiqué: A Critical Examination of the Case for Limited Flexibility of Exchange Rates, Essays in International Finance No. 80, Princeton, May 1970, p. 58.Google Scholar
  96. 2.
    Cf. John Williamson, The Choice of a Pivot for Parities, Essays in International Finance No. 90, Princeton, November 1971, pp. 15–22.Google Scholar
  97. 3.
    IMF, Annual Report, 1972, p. 34.Google Scholar
  98. 4.
    In the IMF’s 1971 Annual Report it was stated that the direct influence of a certain global reserve level on the world conjunctural situation is limited and indirect, whereas increases in reserves (other than SDRs) have a more direct and more substantial inflationary effect (p. 32).Google Scholar
  99. 5.
    Cf. IMF, International Monetary Reform: Documents of the Committee of Twenty, pp. 163–164.Google Scholar
  100. 6.
    Cf. IMF, Annual Report, 1974, p. 39.Google Scholar
  101. 7.
    For a discussion of the motives for holding reserves cf. section i of chapter 6.Google Scholar
  102. 1.
    The situation is different for a reserve currency country, which need not suffer a drain of (gross) reserves while in deficit (cf. section vi of chapter 6). The adjustment process also functions quite differently under a system of floating exchange rates. The need for reserves under such a system is discussed in chapter 7.Google Scholar
  103. 2.
    This concept is explained more fully on p. 90 below.Google Scholar
  104. 3.
    Including the degree up to which the automatic adjustment process is allowed to work. To let it work undisturbed without taking any accentuating, neutralizing or compensating measures can also be a conscious policy decision.Google Scholar
  105. 4.
    Cf. W.M. Scammel, International Monetary Policy, London, 1957, p. 75.Google Scholar
  106. 5.
    Cf. Thomas Balogh, “International Reserves and Liquidity”, Economic Journal, June 1960. Balоgh’s views were discussed at some length in section ν of chapter 4 above.Google Scholar
  107. 1.
    Fritz Machlup, International Monetary Economics, London, 1966, p. 264.Google Scholar
  108. 2.
    IMF, Annual Report, 1963, p. 49.Google Scholar
  109. 3.
    Cf. Oscar L. Altman, “The Management of International Liquidity”, IMF Staff Papers, July 1964.Google Scholar
  110. 4.
    Italics inserted.Google Scholar
  111. 5.
    Altman, p. 238.Google Scholar
  112. 6.
    It is, for instance, alluded to in the objectives of the OECD, which are, inter alia, “to achieve the highest sustainable economic growth and employment and a rising standard of living in member countries, while maintaining financial stability.…” (Article 1(a) of the convention on the Organisation for Economic Co-operation and Development). The treaty of the European Economic Community mentions such objectives as a balanced expansion, greater stability and an increasing improvement in the standard of living (EEC Treaty, Article 2).Google Scholar
  113. 7.
    IMF, Annual Report, 1964, p. 27. There appears to be an element of wishful thinking in this statement. It seems doubtful that in reality all countries attach such high importance to the maintenance of stable prices.Google Scholar
  114. 1.
    Artide XXVIII, Section 1(a) of the (proposed) second amendment of the Articles of Agreement of 1976.Google Scholar
  115. 2.
    The qualification that SDR creation should seek to prevent deflation and not lead to inflation appears to have been explicitly added in view of the fact that the Fund’s purposes (as described in Article I of the Articles of Agreement) do not explicitly mention the maintenance or attainment of price stability.Google Scholar
  116. 3.
    Reserves and the Adjustment Process, Paper prepared by the IMF staff in June 1969. Reproduced in International Reserves: Needs and Availability; op. cit. p. 458.Google Scholar
  117. 4.
    Op. cit., p. 459.Google Scholar
  118. 5.
    For the background of this approach see section ii of chapter 6 below.Google Scholar
  119. 6.
    Cf. Walter S. Salant, “Practical Techniques for Assessing the Need for World Reserves”, in International Reserves: Needs and Availability.Google Scholar
  120. 7.
    Rudolf R. Rhomberg, “Estimation of Effects of Changes in International Reserves”, in International Reserves: Needs and Availability, p. 158.Google Scholar
  121. 1.
    Cf. Salant, p. 276. Salant points out that the estimation of the target value of payments imbalances would ideally require an econometric model of the world economy. On the question of a world macro-model cf. section iv of chapter 6 below.Google Scholar
  122. 1.
    Cf. IMF, Annual Report, 1964, p. 26.Google Scholar
  123. 2.
    The IMF has defined “reserve ease” as a description of an existing reserve situation without any implication as to its adequacy; cf. IMF, Annual Report, 1969, p. 21.Google Scholar
  124. 3.
    Reserves and the Adjustment Process, reproduced in International Reserves: Needs and Availability; op. cit. p. 457. For an interesting view on the impact of the supply of international liquidity on the adjustment process, cf. Richard N. Cooper, “International Liquidity and Balance of Payments Adjustment”, in International Reserves: Needs and Availability.Google Scholar
  125. 1.
    For a description of the adjustment process cf., for instance, Working Party 3 of the Economic Policy Committee of the OECD, The Balance of Payments Adjustment Process, Paris, 1966, and Federal Reserve Bank of Boston, The International Adjustment Mechanism: Proceedings of the Monetary Conference of October 1969. According to Working Party 3 the adjustment process is “essentially a question for governments as to how to achieve a wide range of aims of an economic, political and social nature with the limited number of policy instruments…. available to them.” (The Balance of Payments Adjustment Process, par. 16).Google Scholar
  126. 2.
    Cf. Tibor Scitovsky, Economic Theory and Western European Integration, London/Stanford, 1958, pp. 101–102.Google Scholar
  127. 3.
    James Tobin, “Economic Progress and the International Monetary System”, (1963), reproduced in Bela Balassa (ed.), Changing Patterns in Foreign Trade and Payments, New York, 1964.Google Scholar
  128. 4.
    Peter B. Kenen, “Financing and Adjustment: The Carrot and the Stick”, in Maintaining and Restoring Balance in International Payments (William Fellner, et al), Princeton, 1966, p. 151 et seq.Google Scholar
  129. 5.
    Roy Harrod, “The Speed of Adjustment”, in Maintaining and Restoring Balance in International Payments, pp. 137–143.Google Scholar
  130. 6.
    Cf.,for instance, Otmar Issing, “Zur Frage der Objektiven Beurteilung einer’angemessenen’ Versorgung mit Internationaler Liquidität” (On the Question of an Objective Assessment of an Adequate Supply of International Liquidity), Schweizerische Zeitschrift für Volkswirtschaft und Statistik, March 1967.Google Scholar
  131. 1.
    Cf. Jürg Niehans, “The Need for Reserves of a Single Country”, in International Reserves: Needs and Availability, who notes that: “The different assessment of reserve needs reflects both differences in welfare judgment and differences in views about the working of the macroeconomic system.” (p. 55).Google Scholar

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© Springer Science+Business Media New York 1977

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  • J. A. H. de Beaufort Wijnholds

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