- 2003. of course, it could be argued that the present external imbalance is, to a certain extent,'an attendant phenomenon of success '. fdi inflows having been strong through the entire transition period, reinvested earnings and dividend payments have become increasingly important among the factors determining the current account balance in estonia. the current account figures for the second quarter of this year offer a good illustration for this phenomenon - the primary current account deficit was 7 % of the gdp - more than 6 pp below the actual deficit. at the present time foreign investors are taking into account the perspective of estonia's eu membership within the near future, the optimistic growth forecasts and continuing increase of living standards. due to favourable financing conditions, total investment activity has recently been the highest since the beginning of the transition period - during the first quarter of 2003 investments together with stock building accounted for 38 % of the gdp in estonia. at the same time, a number of small and medium - size enterprises are bringing their production plants in line with eu requirements. and of course, borrowing at the present low interest rates is very attractive to private individuals. but despite all the exceptional one - off factors behind the present high external deficit figures, we must not close our eyes to the fact that the level is high. and reducing the imbalances - with all the attendant stress on increased public and private savings - is presently one of the main priorities for estonia. it must be stressed, in this context, however, that one indicator taken alone - even if it were an indication of possibly unfavourable developments - would not give an adequate picture of the relative health of an economy. that is certainly true of estonia where the level of wages, inflation figures and the changes in productivity would indicate that economic stability is not affected as seriously as indicated by the current account figures taken alone. for instance, the cpi growth in estonia and in the euro area was almost equal in the first half of 2003. according to the present estimates, estonian cpi growth will remain at 1. 5 % in 2003. it could be said that recent inflation developments have been most encouraging. although some temporary effects and weak external pressures have recently helped to ease the inflation pressures, the role of the domestic factors contributing to a steady disinflation process should not be underestimated. but at the same time it should not be forgotten that a gradual increase of price level is an inevitable result of real convergence under a fixed rate of exchange. it

was representative paper money. as long as the relationship between the commodity money and the amount of paper money backed by the commodity money is stable, inflation will be determined by the available supply of commodity money. but the beginning of modern banking, by breaking the strict link between the commodity money and the money supply, added an element of flexibility to the money supply and further opened up the possibility for inflation. during the international gold standard period, currency issue and coin production were linked to and convertible into gold, so that a country ’ s total domestic money supply was tied to the domestic supply of gold. this situation did not guarantee a stable price level, but it did remove the risk of government - induced inflation. the result - - and an indeed an important motivation - - was to constrain and, in principle, eliminate the government ’ s discretion regarding the supply of money. the gold standard, in effect, put in place a rule that governed monetary policy. if a country ran a trade deficit that exceeded private capital inflows, it would, in principle, finance the difference by shipping gold to other countries. doing so reduced the money supply - - and hence income and prices - - in the country with the balance of payments deficit and increased the money supplies, incomes, and prices in the countries with balance of payments surpluses. as a result, the system had the quantity theory of money can be understood in terms of irving fisher ’ s ( 1913 ) equation of exchange : mv = pq, where m = the money supply, v = velocity ( which is defined as the ratio of nominal income ( pq ) to money ), p = the price level, and q = the level of real output. v summarizes the features of the payment system that determine how much money is needed to carry out a given volume of transactions. fisher assumed v was constant and that in the long run q would be determined by the economy ’ s productive capacity and be independent of the money supply. in the face of ongoing financial innovations, v is not constant, and the link between money and prices, even in the long run, is not as precise. in a strict gold standard, there is not opportunity for discretionary monetary policy. however, many countries did not strictly follow the gold standard “ rules, ” and, as a result, squeezed a degree of flexibility for discretionary policy out of the gold standard in practice. a built - in tendency to move the deficit and surplus countries toward balance.