Download Introductory Material (Handa, Chapter 1)

Introductory Material
(Handa, Chapter 1)
Monetary Theory and Policy
Graduate Seminar ECON 6411
Fall 2008
1
What is money?
• Refers to assets that have come to take on certain
roles (or serve certain functions) in an economy.
The specific assets change over time and are
different across societies. These functions are:
–
–
–
–
–
Medium of exchange/payments;
Store of value (temporary abode of purchasing power)
Standard of deferred payments;
Unit of account.
M1, M2, etc.
2
Monetary Base
• Monetary Base (MB): Currency held by the
public and by banks, plus reserves held by
commercial banks on deposit at the Federal
Reserve Banks (FRBs).
• High-powered money is the MB plus
money issue by other monetary authorities
(e.g., the Treasury).
3
What is Monetary Economics?
• Monetary economics is the economics of
the money stock and of its repercussions on
the economy.
• In a monetary economy, virtually all market
transactions involve money.
• Monetary economics has both
microeconomic and macroeconomic
aspects.
4
Microeconomics
• Handa argues that the money market—money
supply and demand, and their equilibrium—is
microeconomic.
• The money market is a simplified summary of a
complex market interaction known as the financial
sector.
• A complete study of monetary economics must
include a study of the financial institutions and
their behavior.
5
Money as Macroeconomics
• In the classical/neoclassical
model, money was the only
variable that was truly
macroeconomic. Thus
macroeconomics was
w/p
monetary economics.
• In later models, money was
shown to influence output
and employment, interest
rates, exports and imports,
exchange rates, and the
balance of payments.
Ns
w0
ys
P
yd
y
Nd
N
Y=F(N,K)
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Money as Macro (2)
• Long-run effects of money include effects on
growth.
• Real analysis vs. monetary analysis.
• Models take many forms:
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–
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Classical/Marshallian
Classical/Walrasian
Keynesian
Neokeynesian (disequilibrium)
Nonwalrasian (e.g., temporary equilibrium models)
Overlapping Generations Models
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Money Supply and Demand
r
r
Ms
Md
M
Market supply of money,
e.g., free banking.
Ms
Md
M
Exogenously determined Ms,
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e.g., by central bank.
Financial Intermediaries
• These organizations stand between ultimate borrowers and
ultimate lenders to facilitate their interaction.
• Banks, mutual funds, pension funds, insurance companies,
etc.
• Intermediaries often repackage assets through was is called
the asset-transmutation process.
• For example, banks may take “short money” as deposits
and create “long money” for loans.
• Note that such assets have offsetting liabilities, so that the
creation of financial assets by intermediaries does not
create net wealth.
9
Inside vs. Outside Money
• Gurley and Shaw (1960) ask: When can money be
considered an asset in portfolios?
• Inside Money: Money created by intermediaries in
which there are offsetting liabilities in the private
sector.
• Outside Money: Money introduced from outside
the private sector, which has no offsetting
liabilities in the private sector.
• According to Gurley and Shaw, outside money is
the only money which is part of the private
sector’s net wealth.
10
Barro’s Ricardian Equivalence
• Barro’s article asks specifically “Are
Government Bonds Net Wealth?”
• In other words, are gov’t bonds held by the
private sector net assets to the private
sector?
• If the issuance of a bond creates a tax
liability to the private sector, then gov’t
bonds are not net wealth.
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Net Wealth
• What about an increase in the money supply?
– What if money supply increases are viewed as
monetizations of debt?
– Gurley and Shaw seem to be arguing that all money,
while an asset to its owner, is a debt for someone else.
• Pesek and Saving view all money as an asset.
They argue that the inside-outside distinction is
irrelevant.
• The creation of high-powered money by the gov’t
is always considered an asset.
12
Some definitions
• Neutrality: Money is neutral if, following a change in the
money supply, a new equilibrium is reach in which all real
variables return to the same values as before the change.
Money is non-neutral otherwise.
• Superneutrality: Money is superneutral if a change in the
growth rate of the money supply does not result in a
change in the capital/labor ratio that exists on the
equilibrium growth path (i.e., the real sector is unchanged).
• Dichotomous Money: A macromodel is said to dichotomize
if a subset of equations can determine the values of all the
real sector variables, with the level of the money supply
playing no role in determining the value of any real
variable.
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General Equilibrium Assumptions
(1)
(2)
(3)
(4)
(5)
(6)
(7)
All Agents Optimize (and on the same thing)
Perfect Information. (All agents seek and find full and free information.)
No Start-up or Setup Costs (Free Entry & Exit)
All Factors are Homogeneous
All Factors are Continuously Variable & Substitutable
Markets Adjust Instantly
Taxes are Neutral
Critical to Pareto Optimality
(8) Complete Markets
(9) All Markets are competitive
(10) No Externalities
(11) Constant Returns to Scale
Critical To Uniqueness
(12) Convex Preferences
(13) Convex Production Isoquants
 dim. marginal rates of transformation and substitution
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