This paper examines the assertion of the monetary approach that the balance of payments for a small, open economy is a purely-monetary phenomenon. Taiwan is a small, open economy employing a fixed exchange rate system. Although the prices and interest rates in Taiwan are not significantly different from the world levels, which satisfies the basic assumptions of the monetary approach, our empirical study finds that monetary factors can only partially explain Taiwan’s balance of payments surplus. This is probably due to the government control over imports and foreign exchange and the sterilization policy executed by the central bank, which causes a more complicated economic adjustment mechanism than the monetary approach suggests.
