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2019 | OriginalPaper | Buchkapitel

2. Money and Long-Run Growth

verfasst von : Jin Cao, Gerhard Illing

Erschienen in: Money: Theory and Practice

Verlag: Springer International Publishing

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Abstract

This chapter looks at monetary policy design from a classical, long-term perspective. We consider a dynamic growth model with flexible prices, assuming that money will not affect real variables in the long run. We introduce various frictions to provide a microfoundation for money holding and show that, formally, the role for money generated by these frictions can be captured in a quite general way by the “money in the utility function” approach. By construction, the role of monetary policy is fairly limited in that context and straightforward to characterize: Central banks should aim to implement the Friedman rule to achieve price stability (low inflation), thus minimizing distortions arising from holding money balances. We show, however, that price level and inflation are determined not just by current monetary policy, but by the expected future path of monetary policy across time and analyze conditions to rule out indeterminacy with bubbles and self-fulfilling inflationary expectations.

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Vorheriges Kapitel Long-Run Growth: The Basic Framework

Nächstes Kapitel Interaction Between Monetary and Fiscal Policy: Active and Passive Monetary Regimes

“Somehow the members of a society agree on what will be acceptable tender in making payments and settling debts among themselves (particular commodities or tokens as measures of value and media of exchange in economic transactions). General agreement to the convention, not the particular media agreed upon, is the source of money’s immense value to the society. In this respect money is similar to language, standard time, or the convention designating the side of the road for passing.” (Tobin, 1992).

“To account, then, for this phenomenon, we must consider, that though the high price of commodities is a necessary consequence of the increase of gold and silver, yet it follows not immediately upon that increase; but some time is required before the money circulates through the whole state, and makes its effect be felt on all ranks of people.”

Things get more complex when at least some prices are sticky. If so, the central bank can steer the short run real rate of interest by changing the nominal rate, as long as this policy has no adverse impact on inflationary expectations! We look at these issues in part II, starting with Chap. 4.

In a world with perfectly flexible prices, the nominal interest rate is determined by the sum of the natural real rate and expected inflation. With a share of prices being sticky and well-anchored expected inflation, monetary policy can a affect the real rate of interest by changing the nominal rate. This mechanism is the core transmission channel of modern monetary policy, analyzed in detail in Chap. 4. In this chapter, we rule this channel out by construction, focusing on the case of perfectly flexible prices.

Note: $ {\sum}_{s=0}^{\infty}{\left(\frac{b}{1+b}\right)}^s=1+b $; $ {\sum}_{s=0}^{\infty}s{\left(\frac{b}{1+b}\right)}^s=b\left(1+b\right) $.

Insert $ {m}_{t_0+T-2}={m}_1 $ and Equation 2.2.10 for $ E\left({p}_{t_0+T-1}\right) $ to solve for $ {m}_{t_0+T-2}-{p}_{t_0+T-2}=-b\left[{E}_{t_0+T-1}\left({p}_{t_0+T-1}\right)-{p}_{t_0+T-2}\right]. $

Note, however, that in this chapter, we only consider long-run issues, neglecting stabilization policy.

There are, however, strong debates about the best strategy. In particular when monetary policy is impeded by the fact that interest rates cannot be reduced below some effective lower bound, a level-based targeting approach may be preferable in order to credibly prevent deflationary spirals. Targeting the price level could be a credible commitment to allow for higher rates of inflation until the intended path has been reached without undermining central bank credibility in the long run (see Chap. 7).

When interest $ {i}_t^M $ is paid on money, the opportunity cost reduces to $ \left({i}_t-{i}_t^M\right)/\left(1+{i}_t\right) $.

More generally: A stochastic bursting bubble can also be a solution, if

$$ {b}_{t+1}=\{{\displaystyle \begin{array}{c}\frac{b+1}{b}\frac{1}{p}{b}_t+{v}_{t+1},\kern2em \mathrm{with}\ \mathrm{prob}\ p,\\ {}{v}_{t+1},\kern5.5em \mathrm{with}\ \mathrm{prob}\ 1-p,\end{array}}\operatorname{}\kern2em \mathrm{and}\ {E}_t\left({v}_{t+1}\right)=0. $$

More generally, in an economy growing with rate $ \gamma $, we have $ 1+\mu =\left(1+\gamma \right)\left(1+\pi \right) $.

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Titel: Money and Long-Run Growth
verfasst von: Jin Cao
Gerhard Illing
Verlag: Springer International Publishing
Buch: Money: Theory and Practice
Print ISBN: 978-3-030-19696-7

Electronic ISBN: 978-3-030-19697-4

Copyright-Jahr: 2019
DOI: https://doi.org/10.1007/978-3-030-19697-4_2