Inadequate mechanism for balance of payments adjustment

The adjustment process is the process whereby unintended deficits and surpluses in the balance of payments on current and long-term capital account (which have to be financed either by compensatory short-term capital flows or by movements of reserves) are eliminated. There are certain inherent forces tending to reverse any departure from balance-of-payments equilibrium. Thus an import balance may tend to depress the level of domestic activity and hence the subsequent demand for imports. The impact of automatic mechanisms of adjustment of this type varies greatly from country to country, depending on the size of foreign transactions in relation to the gross national product. The automatic process of adjustment may also be damped or offset by countervailing domestic monetary or fiscal policies. It is therefore not possible to rely on spontaneous forces either to bring about adjustment within a reasonable time or to distribute the burden of adjustment equitably as between deficit and surplus countries. If adjustment is unduly delayed, the disequilibrium may be accentuated by speculative flows of short-term capital.