The determinants of international reserves in the small open economy: The case of Honduras

The strong monetary approach to the balance of payments suggests that for a small open economy with a fixed exchange rate, international-reserve losses are due to money-supply growth in excess of growth in money demand, where money demand is assumed to be a stable function of exogenously given income and world prices. This paper tests the applicability of the strong monetary approach to Honduras during the period 1960–1983. Although the strong monetary approach provides a statistical explanation of reserve movements during this period, insights into the underlying causes of reserve changes can be obtained through recognition of the importance of the income terms of trade in determining both real income and domestic-credit growth in the small open economy.