A floating exchange rate regime is conducive to creating a lasting balance in a country´s external payments flow. This is partly due to elimination of abrupt exchange rate adjustments. It has been evidenced, though, that it does not preclude the risk of a currency crisis. If we acknowledge that sustainable payments balance may be exposed even under a floating exchange rate regime, the question arises as to the central bank´s role in restoring that balance.

Appropriate measures by the central bank may act as an adjustment of monetary policy. In this case, however, we need to resolve issues such as the desired direction of the change; its effectiveness - as well as limitations - in improving the balance of payments; possible clash with other monetary policy goals.

We seek to answer these questions through an analysis based on the interest rate parity theory, the Miller-Modigliani proposition and the Mundell-Fleming model. The analysis leads to one conclusion: under a floating exchange rate regime, the balance of payments is solely affected through the expenditure-switching effect. Within the economic system - as we see it - it is possible to exert lasting influence upon both the current and capital (portfolio investment) account balances by adjusting the supply of money. That holds even under perfect capital mobility, with interest parity condition observed.

An effective reduction in the current account deficit is not possible through monetary policy money supply growth is neutral versus the real economy. This is especially the case under full capacity utilization. Such a situation additionally excludes the occurence of expenditure-switching effect, e.g. a shift towards satisfying, in a greater measure, domestic demand by domestic supply. In practice, trying to curb current account deficits by monetary relaxation only makes sense if monetary policy is restrictive towards domestic expenditure at a level not substantially above potential GDP. Even then, such a move may be in conflict with the inflationary target.

Situations which justify the application of monetary policies in fighting CA deficits are therefore fairly restricted. If a country´s lasting payments balance is at risk, it is rather due to excessive domestic expenditure - above the level of the economy´s capacity - than overly restrictive monetary policy. What becomes important under such circumstances, are the factors encouraging domestic agents to resort to foreign financing - and foreign agents to provide, in spite of the risk involved, the finance for the extensive spending. The situation tends to be interpreted as market imperfection. The final part of the paper provides examples as well as suggested central bank policies in dealing with market imperfections.