Monetary Economics

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ISBN: 9780415199254 | 0415199255
Cover: Hardcover
Copyright: 8/4/2000

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This text breaks new ground in developing an integrated and comprehensive overview of advanced monetary economics. It integrates the presentation of monetary theory with empirical formulations and their empirical tests. Unlike most texts this book brings together in a single unified source the core areas of monentary economics.

Preface

Acknowledgments

xvii

part one INTRODUCTION AND HERITAGE

(52)

Introduction

(22)

Key concepts introduced in this chapter

(2)

What is money and what does it do?

(1)

Money supply and money stock

(1)

The nominal versus the real value of the money supply

(1)

The money market in monetary and macroeconomics

(1)

A brief history of the definition of money

(3)

The practical definitions of money and related concepts

(2)

Financial intermediaries and the creation of financial assets

(2)

Different modes of analysing the economy

(1)

The classical paradigm and the classical set of macroeconomic models

(2)

The Keynesian paradigm and the Keynesian set of macroeconomic models

(2)

Which macro-paradigm or model must one believe in?

(1)

The parameters of the IS-LM expositions of macroeconomic models

(1)

Monetary and fiscal policies

(4)

Conclusions

(1)

Summary of critical conclusions

(1)

Review and discussion questions

(3)

The analysis of money and prices: the heritage

(29)

Key concepts introduced in this chapter

(1)

The quantity equation

(2)

The quantity theory

(6)

Wicksell's pure credit economy

(2)

Keynes' contributions on the demand for money

(7)

Friedman and the `restatement' of the quantity theory of money

(3)

The transmission mechanisms for the impact of money supply changes on national income

(8)

Conclusions

(2)

Summary of critical conclusions

(1)

Review and discussion questions

(3)

part two MONEY IN THE ECONOMY

(32)

Money in the economy: general equilibrium analysis

(31)

Key concepts introduced in this chapter

(1)

Money and other goods in the economy

(1)

Inserting money into the individual's utility function

(3)

The different concepts of prices

(1)

The user cost of money

(1)

The individual's demand for and supply of money and other goods

(2)

The firm's demand and supply functions for money and other goods

(4)

The aggregate demand and supply functions for money and other goods in the economy

(1)

The supply of nominal and real balances

(1)

General equilibrium in the economy

(2)

The neutrality and super-neutrality of money

(4)

The dichotomy between the real and the monetary sectors

(3)

Simplifying the aggregate demand function for money for macroeconomic analysis

(9)

Conclusions

(1)

Summary of critical conclusions

(1)

Review and discussion questions

(5)

part three THE DEMAND FOR MONEY

(146)

The transactions demand for money

(13)

Key concepts introduced in this chapter

(1)

The basic inventory analysis of the transactions demand for money

(3)

Some special cases of the demand for transactions balances

(1)

The demand for currency versus demand deposits

(1)

Economies of scale and the distribution of income

(1)

Efficient funds management in a firm with multiple branches

(1)

The demand for money and the payment of interest on demand deposits

(1)

Technical innovations and the demand for currency, and for demand and savings deposits

(1)

Demand deposits versus savings deposits

(1)

Impending financial innovations

(4)

Conclusions

(2)

Summary of critical conclusions

(1)

Review and discussion questions

(2)

Portfolio selection and the speculative demand for money

(29)

Key concepts introduced in this chapter

(2)

Probabilities, means and variances

101

(1)

Wealth maximization versus expected utility maximization

102

(1)

Risk preference, indifference and aversion

103

(1)

The expected utility hypothesis of portfolio selection

104

(2)

The efficient opportunity locus

106

(6)

Tobin's analysis of the demand for a riskless asset versus a risky one

112

(3)

The expected utility hypothesis (EUH) and specific forms of the utility function

115

(5)

The volatility of money demand functions

120

(1)

An important caution: is there a positive demand for speculative balances in the modern economy?

121

(7)

Conclusions

122

(1)

Summary of critical conclusions

122

(1)

Review and discussion questions

123

(5)

The precautionary and buffer stock demand for money

128

(23)

Key concepts introduced in this chapter

128

(2)

An extension of the transactions demand model to precautionary demand

130

(3)

The precautionary demand for money with overdrafts

133

(2)

The precautionary demand for money without overdrafts

135

(1)

Buffer stock models

136

(2)

Buffer stock rule models

138

(4)

Buffer stock smoothing or objective models

142

(9)

Conclusions

146

(1)

Summary of critical conclusions

147

(1)

Review and discussion questions

148

(3)

The estimating function for the demand for money

151

(25)

Key concepts introduced in this chapter

151

(1)

Permanent or expected income in the money demand function

152

(2)

Rational expectations

154

(5)

Adaptive expectations (geometric distributed lag) for the derivation of permanent income

159

(2)

Regressive and extrapolative expectations

161

(1)

Lags in adjustment and the costs of changing money balances

161

(2)

Money demand with the first-order PAM

163

(1)

Money demand with the first-order PAM and adaptive expectations of permanent income

163

(1)

The general autoregressive distributed lag model

164

(2)

Caveat emptor: an introduction to common econometric lapses in the estimation of money demand

166

(4)

The functional form of the money demand function

170

(6)

Conclusions

171

(1)

Summary of critical conclusions

172

(1)

Review and discussion questions

173

(3)

Monetary aggregation

176

(27)

Key concepts introduced in this chapter

176

(2)

The appropriate definition of money: theoretical considerations

178

(1)

Money as the explanatory variable for nominal national income

178

(1)

Weak separability

179

(2)

Simple sum monetary aggregates

181

(1)

The variable elasticity of substitution and near-monies

182

(3)

The user cost of assets

185

(1)

Index number theory and Divisia aggregates

186

(2)

Judging among the monetary aggregates

188

(15)

Conclusions

193

(1)

Appendix: Divisia aggregation

194

(4)

Summary of critical conclusions

198

(1)

Review and discussion questions

198

(5)

The demand function for money: empirical findings

203

(28)

Key concepts introduced in this chapter

203

(1)

Income and/or wealth as the determinant of money demand

204

(1)

The relevant interest rate in the money demand function

205

(1)

The liquidity trap

205

(1)

Money demand and the expected rate of inflation

206

(1)

Shifts of the money demand function

207

(1)

Changes in the exchange rate and currency substitution in the money demand function

208

(3)

A brief historical review of the estimation of money demand

211

(3)

The basics of unit roots, cointegration and error-correction techniques

214

(4)

Some cointegration studies of the money demand function

218

(1)

Empirical studies on the buffer stock models of the demand for money

219

(12)

Conclusions

224

(2)

Summary of critical conclusions

226

(1)

Review and discussion questions

226

(5)

part four MONEY SUPPLY AND CENTRAL BANKING

231

(98)

The money supply process

232

(20)

Key concepts introduced in this chapter

232

(1)

The supply of the monetary base by the central bank

233

(1)

The demand for currency by the public

234

(2)

Commercial banks: the demand for reserves

236

(3)

Mechanical theories of the money supply: money supply identities

239

(3)

A behavioural theory of the money supply

242

(1)

The general money supply function and its empirical estimates

243

(2)

Interest rate elasticities of the money supply

245

(1)

Cointegration and error-correction models of the money supply

246

(6)

Conclusions

247

(1)

Summary of critical conclusions

248

(1)

Review and discussion questions

248

(4)

The central bank: goals, tools and guides for monetary policy

252

(32)

Key concepts introduced in this chapter

252

(1)

The historic goals of central banks

253

(2)

The evolution of the goals of central banks

255

(5)

Levels of objectives

260

(1)

The tools or instruments of monetary policy

261

(5)

The competitive supply of money and efficiency and competition in the financial sector

266

(3)

Administered interest rates and economic performance

269

(1)

The regulation of banks relative to other financial intermediaries

270

(2)

The Federal Reserve System: objectives, instruments and guides to monetary policy

272

(1)

The objectives, instruments and guides to monetary policy of the British monetary authorities

273

(2)

The Bank of Canada: objectives, instruments and guides to monetary policy

275

(1)

The European System of Central Banks (ESCB) and the European Central Bank (ECB)

276

(1)

Currency boards

277

(7)

Conclusions

278

(1)

Summary of critical conclusions

279

(1)

Review and discussion questions

279

(5)

The central bank: targets, conflicts, independence and the time consistency of policies

284

(45)

Key concepts introduced in this chapter

284

(1)

Guides to monetary policy

285

(1)

The relationship among goals, targets and guides to policy, and difficulties in the pursuit of monetary policy

286

(1)

The targets of monetary policy

287

(5)

Monetary and reserve aggregates as targets

292

(2)

Interest rates as targets

294

(2)

The price level or the rate of inflation as a target

296

(1)

Nominal national income as a target

297

(2)

Targeting the deviation of output from full employment

299

(1)

Choosing among multiple goals

299

(4)

The conflicts among policy makers: theoretical analysis

303

(1)

The conflicts among policy makers: empirical illustrations

304

(3)

The independence of the central bank

307

(2)

Time-consistent policies versus discretionary ones, and policy rules

309

(5)

The credibility of monetary policy

314

(15)

Conclusions

321

(2)

Summary of critical conclusions

323

(1)

Review and discussion questions

323

(6)

part five MONEY IN THE MACROECONOMY

329

(176)

The classical paradigm in macroeconomics: neoclassical and classical models

330

(49)

Key concepts introduced in this chapter

330

(1)

The evolution of the classical paradigm

331

(2)

The boundaries of the short-run macroeconomic models

333

(1)

The definition of the short run in macroeconomic models

334

(1)

The commodity sector

335

(4)

The monetary sector

339

(1)

The commodity and monetary sectors combined: the aggregate demand for commodities

340

(1)

The supply side of the neoclassical model

341

(4)

General equilibrium: aggregate demand and supply analysis

345

(1)

Comparative static policy effects

346

(2)

The iterative structure of the neoclassical model

348

(3)

The comparative statics of the neoclassical model in a diagrammatic form

351

(2)

Special cases of the IS-LM analysis and the neoclassical-Keynesian synthesis

353

(1)

The four fundamental assumptions for the Walrasian equilibrium of the neoclassical model

354

(1)

Disequilibrium in the neoclassical model and the non-neutrality of money

355

(5)

The relationship between the money supply and the price level: the heritage of ideas

360

(1)

The classical and neoclassical tradition, economic liberalism and laissez faire

361

(2)

Ricardian equivalence and the return to classical orthodoxy

363

(3)

Defining and demarcating the models of the classical paradigm

366

(1)

Milton Friedman and monetarism

367

(12)

Conclusions

370

(2)

Appendix: the propositions of Ricardian equivalence and the evolution of the public debt

372

(1)

Summary of critical conclusions

373

(1)

Review and discussion questions

373

(6)

The Keynesian and neo-Keynesian approaches to short-run macroeconomics

379

(40)

Key concepts introduced in this chapter

379

(3)

Keynesian model I: the nominal wage model

382

(7)

Keynesian model II: Keynesian models with the Phillips curve

389

(2)

Keynesian model III: Keynesian models without labour market clearance

391

(1)

Keynesian model IV: quantity-constrained analysis

392

(7)

Neo-Keynesian economics

399

(5)

The reduced-form equations for output and employment in the Keynesian and neoclassical approaches

404

(2)

Keynesian economics and Ricardian equivalence

406

(1)

Mercantilism, liberalism, and classical and Keynesian economics

407

(12)

Conclusions

408

(4)

Summary of critical conclusions

412

(1)

Review and discussion questions

413

(6)

Expectations in macroeconomics and monetary policy

419

(31)

Key concepts introduced in this chapter

419

(1)

The nature of risk, uncertainty and expectations in economics

420

(1)

Expectations hypotheses

420

(2)

Expectations and the labour market: the expectations augmented Phillips curve

422

(7)

Price expectations and commodity markets: the Lucas supply function

429

(3)

The relationship between output, prices and changes in aggregate demand in the Lucas model

432

(3)

Testing the neoclassical and Keynesian hypotheses on the effectiveness of monetary policy: estimates based on the Lucas model

435

(3)

Distinguishing between the impact of positive and negative money supply shocks

438

(1)

Testing the neoclassical and Keynesian hypotheses on the effectiveness of monetary policy: estimates from a Keynesian model with a Phillips curve

439

(1)

Testing the neoclassical and Keynesian hypotheses on the effectiveness of monetary policy: the results of other testing procedures

440

(1)

Summing up the empirical evidence on monetary neutrality and rational expectations

441

(9)

Conclusions

441

(2)

Summary of critical conclusions

443

(1)

Review and discussion questions

443

(7)

Macro models, policy rules and perspectives on the neutrality of money

450

(28)

Key concepts introduced in this chapter

450

(1)

Discretionary monetary policy versus simple monetary policy rules

451

(2)

The Lucas-Sargent-Wallace (LSW) model

453

(6)

The Lucas critique in the Lucas-Sargent-Wallace model

459

(1)

Policy irrelevance with a pseudo-Keynesian supply function and the Lucas critique

460

(1)

Monetary policy rules

461

(4)

Lags in the effects of monetary policy

465

(2)

Long lags and the Lucas-Sargent-Wallace model

467

(11)

Conclusions

468

(4)

Summary of critical conclusions

472

(1)

Review and discussion questions

473

(5)

Walras' law and the interaction among markets

478

(27)

Key concepts introduced in this chapter

478

(1)

Walras' law

479

(3)

The application of Walras' law in the IS-LM models: the excess demand for bonds

482

(2)

Walras' law and the selection among the markets for a model

484

(1)

Two implications of Walras' law

485

(2)

Say's law

487

(3)

The dichotomy between the real and monetary sectors

490

(1)

The real balance effect

490

(3)

The neutrality of money and the real balance effect

493

(1)

The wealth effect

493

(1)

Is Walras' law really a law: when might it not hold?

494

(3)

Reformulating Walras' law: the Clower and Dreze effective demand and supply functions

497

(8)

Conclusions

499

(1)

Summary of critical conclusions

500

(1)

Review and discussion questions

500

(5)

part six MONEY IN THE OPEN ECONOMY

505

(62)

The open economy: exchange rates and the balance of payments

506

(22)

New concepts introduced in this chapter

506

(1)

Exchange rates

507

(3)

The balance of payments

510

(1)

The balance of payments in an accounting sense

511

(2)

The demand and supply of foreign exchange and the changes in foreign exchange reserves

513

(2)

Flexible exchange rates

515

(3)

Purchasing power parity (PPP)

518

(1)

Interest rate parity (IRP)

519

(1)

Fixed exchange rates

520

(1)

The International Monetary Fund (IMF)

520

(8)

Conclusions

523

(1)

Summary of critical conclusions

524

(1)

Review and discussion questions

524

(4)

The macroeconomic model for the open economy

528

(39)

Key concepts introduced in this chapter

528

(1)

The macroeconomic model for an open economy

529

(7)

The general equilibrium IS-LM model for the open economy

536

(2)

Managing aggregate demand in the open economy: monetary and fiscal policies under flexible exchange rates

538

(1)

Managing aggregate demand in the open economy: monetary and fiscal policies under fixed exchange rates

538

(3)

Bringing aggregate supply into the analysis

541

(1)

Macroeconomic equilibrium in the small open economy with full employment and IRP

541

(2)

PPP, the world rate of inflation and the convergence in national inflation rates

543

(1)

Disequilibrium in the domestic economy and stabilization through monetary and fiscal policies

544

(3)

The choice between fixed and flexible exchange rate regimes

547

(1)

Compact models for the open economy: the monetary approach to exchange rates (MAER)

548

(3)

Compact models of the open economy: the Dornbusch model

551

(6)

Empirical evidence on PPP

557

(2)

Empirical evidence on interest rate parity

559

(8)

Conclusions

559

(1)

Summary of critical conclusions

560

(1)

Review and discussion questions

561

(6)

part seven THE RATES OF INTEREST IN THE ECONOMY

567

(58)

The macroeconomic theory of the rate of interest

568

(27)

Key concepts introduced in this chapter

568

(1)

Nominal and real rates of interest

569

(1)

The loanable funds theory of the rate of interest

570

(3)

A historical incursion: the traditional classical loanable funds theory of the rate of interest

573

(5)

The liquidity preference theory of interest

578

(1)

The liquidity preference versus the loanable funds theories of interest in comparative static analysis

579

(2)

The liquidity preference versus the loanable funds theories of interest in dynamic analysis

581

(1)

The bond market in the IS-LM diagram

582

(2)

The diagrammatic analysis of dynamic changes in the rate of interest

584

(1)

Intuition on the choice between the liquidity preference and loanable funds theories

585

(1)

The neutrality of money for the real rate of interest

586

(2)

Testing the Fisher equation of the nominal interest rate

588

(1)

Testing the liquidity preference and loanable funds theories

588

(7)

Conclusions

590

(1)

Summary of critical conclusions

591

(1)

Review and discussion questions

592

(3)

The structure of interest rates

595

(30)

Key concepts introduced in this chapter

595

(2)

Some of the concepts of the rate of interest

597

(1)

The term structure of interest rates

597

(6)

Financial asset prices

603

(1)

Empirical estimation and tests

604

(4)

Tests of the expectations hypothesis with a constant premium and rational expectations

608

(2)

The random walk hypothesis of the long rates of interest

610

(2)

The information content of the term structure for the expected rates of inflation

612

(2)

The risk structure of interest rates: the Capital Asset Pricing Model

614

(11)

Conclusions

616

(1)

Appendix: the Capital Asset Pricing Model

617

(4)

Summary of critical conclusions

621

(1)

Review and discussion questions

621

(4)

part eight OVERLAPPING GENERATIONS MODELS OF MONEY

625

(72)

The overlapping generations model of fiat money

626

(23)

Key concepts introduced in this chapter

626

(2)

The basic OLG model

628

(6)

The basic OLG model with a growing population

634

(1)

Welfare in the basic OLG model

635

(2)

The basic OLG model with a growing money supply and with a growing population

637

(1)

The inefficiency of monetary expansion (money transfer case)

638

(3)

The inefficiency of price stability with monetary expansion and population growth

641

(1)

Money demand in the OLG model with a positive rate of time preference

641

(1)

Several fiat monies

642

(7)

Conclusions

643

(1)

Summary of critical conclusions

644

(1)

Review and discussion questions

645

(4)

The OLG model: seigniorage, bonds and the neutrality of fiat money

649

(25)

Key concepts introduced in this chapter

649

(1)

The seigniorage from fiat money and its uses

650

(4)

Fiat money and bonds

654

(2)

The Wallace--Modigliani--Miller (W--M--M) theorem on open market operations

656

(3)

An illustration: an OLG model with money, capital and production

659

(4)

The neutrality and non-neutrality of money in OLG models

663

(2)

Do the OLG models explain the major facets of a monetary economy?

665

(9)

Conclusions

668

(2)

Summary of critical conclusions

670

(1)

Review and discussion questions

671

(3)

The OLG model of money: making it more realistic

674

(23)

Key concepts introduced in this chapter

674

(2)

A T-period cash-in-advance money-bonds model

676

(6)

An extended OLG model with transactions time for consumers and the indirect MIUF

682

(5)

An extended OLG model for firms with money indirectly in the production function (MIPF)

687

(4)

The basic OLG model with the indirect MIUF and MIPF

691

(6)

Conclusions

692

(1)

Summary of critical conclusions

693

(1)

Review and discussion questions

694

(3)

part nine MONEY AND FINANCIAL INSTITUTIONS IN GROWTH THEORY

697

(58)

Neoclassical growth theory without money

698

(31)

Key concepts introduced in this chapter

698

(2)

Setting the boundaries of macroeconomic growth theory

700

(1)

The basic (Solow's) neoclassical growth model

701

(5)

Growth theory if there is increasing marginal productivity of capital (MPK)

706

(3)

Assessing the importance of technical change in the basic neoclassical model

709

(1)

The basic neoclassical growth model with exogenous technical change

710

(1)

Endogenous growth theories

711

(3)

A simplified model of endogenous growth

714

(5)

Another endogenous growth model

719

(1)

The process of endogenous technical change and its negative externalities

720

(1)

Implications of endogenous growth theories for macroeconomic policy

721

(1)

International linkages and growth

722

(7)

Conclusions

723

(2)

Summary of critical conclusions

725

(1)

Review and discussion questions

726

(3)

Monetary growth theory

729

(26)

Key concepts introduced in this chapter

729

(3)

Commodity-money, real balances and growth theory

732

(2)

Real fiat balances in disposable income, and growth

734

(2)

Real fiat balances in the static production function

736

(1)

Reformulation of the neoclassical model with money in the static production and utility functions

736

(3)

Why and how does money contribute to per capita output and its growth rate?

739

(1)

How does the use of money change the labour supplied for production?

740

(1)

The distinction between inside and outside money

740

(1)

Financial intermediation (FI) in the growth and development processes

741

(4)

Empirical evidence on the importance of money and the financial sector to growth

745

(2)

A simplified growth model of endogenous technical change involving the financial sector

747

(1)

Investment, financial intermediation and economic development

748

(7)

Conclusions

749

(2)

Summary of critical conclusions

751

(1)

Review and discussion questions

751

(4)

Index

755

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Monetary Economics

Summary

Author Biography

Table of Contents

Supplemental Materials

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Monetary Economics

Summary

Author Biography

Table of Contents

Supplemental Materials

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