MONEY, MACROECONOMICS AND KEYNES phần 2 potx

Were the discussion then to turn to the actual conduct of policy, however, thosesame central bankers would probably agree that the framework that they actuallydeploy in setting the day-t

base/bank deposit multiplier provided a simple and concise way of explaining

his-torical developments Yet other Monetarists feel perfectly happy with the i vL v

M vH model.

So, while my belief is that more Monetarists accept, and teach, the H vM vi

model, and that as you progress through Keynesian to various factions of

post-Keynesians, an increasingly larger proportion reject H vM vi (with many accepting i vL vM vH), it is hard to argue that the issue is primarily ideological.

So what has caused academic monetary theory to be out-of-step with reality for

so long?

One view of the failings of economics is that it is too abstruse and ical I believe that to be wrong In financial economics (finance) complex maths,e.g the Black/Scholes formula and the pricing of derivatives, goes most success-fully hand-in-hand with practical and empirical work My own criticism, instead,

mathemat-is that large parts of macroeconomics are insufficiently empirical; assumptionsare not tested against the facts Otherwise how could economists have gone on

believing that central banks set H, not i?9

Insofar as the relevant empirical underpinnings of macroeconomics areignored, undervalued or relatively costly to study, it leaves theory too much in thegrasp of fashion, with mathematical elegance and intellectual cleverness beingprized above practical relevance In the particular branch of monetary theorydescribed here, that had remained the case for decades, at least until recentlywhen matters have been greatly improving

5 Summary and conclusions

1 In their analysis most economists have assumed that central banks nously’ set the high-powered monetary base, so that (short-term) interestrates are ‘endogenously’ set in the money market

‘exoge-2 Victoria Chick is one of the few economists to emphasise that the above sis is wrong Central banks set short-term interest rates according to some

analy-‘reaction function’ and the monetary base (H ) is an endogenous variable.

3 This latter has been better understood in practical policy discussions than in(pedagogical) analysis, so this common error has had less obvious adverse con-sequences for policy decisions (in the UK at least) than for analytical clarity

4 At last, after decades in which practical policy makers in central banks andacademics have often been talking at cross-purposes, more recently leadingtheorists, e.g Svensson, Taylor, Woodford, have been narrowing the gapbetween academics and practitioners

2 See Sayers (1976, chapter 3, especially p 28) Also see Sayers (1957, especially chapter 2, pp 8–19) on ‘Central Banking after Bagehot’.

3 For a current example, see Handa (2000, chapter 10); but also Mankiw, 4th edn (2000,chapter 18), Branson, 3rd edn (1989, chapter 15), Burda and Wyplosz (1997, chapter9.2), and many others

4 See, for example, Chick (1973, chapter 5, section 5.7), on ‘The Exogeneity Issue’,

pp 83–90

5 As noted earlier, this was a function of the differential between Fed Funds rate and theDiscount rate Given the Discount rate, there is a belief that the Fed chose a desired FedFunds rate, and then just derived the implied associated borrowed reserves target (seeThornton 1988)

6 There are numerous reasons for this, several of which, including those usually put ward in the time inconsistency literature, are, however, neither convincing nor supported

for-by much empirical evidence Nevertheless better reasons can be found, see Bean (1998)and Goodhart (1998)

7 This is not the place to discuss over-funding, or the implications of trying to influencethe slope of the yield curve

8 Since what matters for economic policy are these predictable regular feedback ships, it is, perhaps, not surprising that econometric techniques that focus on the erratic

relation-innovations (in i, or M ) to identify monetary policy impulses, e.g in VARs, have been

coming under criticism from economists such as Rudesbusch and McCallum

9 This is not just apparent in monetary economics The whole development of rationalexpectations theorising has appeared to proceed with minimal concern about what itactually is rational for people to expect in a world where learning is costly and timeshort; and about what people do expect, and how they learn and adjust their expecta-tions Much the same could be said for models of perfectly flexible wage/price variation,

or for models assuming some form of stickiness There remains limited empiricalknowledge of what determines the speed and extent of wage/price flexibility

Burda, M and Wyplosz, C (1997) Macroeconomics: A European Text, 2nd edn Oxford:

Oxford University Press

Chick, V (1973) The Theory of Monetary Policy, revised edn Oxford: Basil Blackwell.

Chick, V (1992) ‘The Evolution of the Banking System and the Theory of Saving,

Investment and Interest’, in P Arestis and S Dow (eds), Chapter 12 in On Money, Method and Keynes: Selected Essays New York: St Martins Press.

Goodhart, C (1989) ‘The Conduct of Monetary Policy’, Economic Journal, 99, 293–346.

Goodhart, C (1998) ‘Central Bankers and Uncertainty’, Keynes Lecture in Economics,

Oct 29, reprinted in Proceedings of the British Academy, 101, 229–71 (1999) and in the Bank of England Quarterly Bulletin, 39(4), 102–20 (1999).

Handa, J (2000) Monetary Economics London: Routledge.

Keynes, J M (1930) A Treatise on Money London: Macmillan.

Laidler, D E W (ed.) (1999) The Foundations of Monetary Economics Cheltenham, UK:

Edward Elgar

Mankiw, N G (2000) Macroeconomics, New York: Worth Publishers.

Meade, J E (1934) ‘The Amount of Money and the Banking System’, Economic Journal,

XLIV, 77–83

Phillips, C A (1920) Bank Credit New York: Macmillan.

Rasche, R H and Johannes, J M (1987) Controlling the Growth of Monetary Aggregates.

Dordrecht, Netherlands, Kluwer Academic Publishers

Sargent, T J and Wallace, N (1975) ‘ “Rational” Expectations, the Optimal Monetary

Instrument, and the Optimal Money Supply Rule’, Journal of Political Economy, 83(2),

241–54

Sayers, R S (1957) Central Banking after Bagehot Oxford: Clarendon Press.

Sayers, R S (1976) The Bank of England, 1891–1944 Cambridge: Cambridge University

Press

Svensson, L (1999) ‘How should Monetary Policy be Conducted in an Era of PriceStability’, Centre for Economic Policy Research, Discussion Paper No 2342(December)

Thornton, D L (1988) ‘The Borrowed-Reserves Operating Procedure: Theory and

Evidence’, Federal Reserve Bank of St Louis Review (January/February), 30–54.

Tobin, J (1963) ‘Commercial Banks as Creators of “Money” ’, in D Carson (ed.),

Banking and Monetary Studies Homewood, Illinois: Richard D Irwin Inc.

Woodford, M (2000) Interest and Prices, draft of forthcoming book (April).

me about this, when we first met at LSE in 1961–2, at a time when very few ple thought that questions about the quantity of money were worth serious dis-cussion Vicky and I did at least agree that ‘money mattered’, though not aboutmuch else And so it has been ever since But I have always learned from our dis-cussions, so what better topic for an essay in her honour than endogenous money,and its causative role in the transmission mechanism of monetary policy?

peo-2 The role of monetary policy

If one were to discuss monetary policy with a representative group of centralbankers, they would probably agree with the following four propositions: (i)Monetary policy should be focused on the control of inflation (ii) In the long run,

the logarithmic growth rate of real income, dy/dt, is beyond their direct control –

though many supporters of inflation targeting would suggest that this variable’s

average value might be a bit higher were the inflation rate, dp/dt, low and stable,

as opposed to high and variable (iii) Velocity’s long-run logarithmic rate of

change, dv/dt, is largely a matter of institutional change – and to that extent again

beyond the direct control of policy (iv) The critical variable determining the tion rate, again in the long run, is the logarithmic rate of growth of some repre-

infla-sentative monetary aggregate, dm/dt In short, they would probably assent to the

following formulation of the income version of the quantity theory of money:

They would also agree that, within this equation, the important action, as far as

their task is concerned, involves the influence of dm/dt on dp/dt.

Were the discussion then to turn to the actual conduct of policy, however, thosesame central bankers would probably agree that the framework that they actuallydeploy in setting the day-to-day course of monetary policy was some variation on

a model whose basic structure can be set out in three equations: namely, an

expec-tations augmented Phillips curve, an IS curve, and a Fisher equation linking the real rate of interest that appears on the right-hand side of the IS curve to a nomi-

nal rate that is a policy instrument, and hence an exogenous variable This rathersparse framework must, of course, be filled out with many details in order tobecome a practical vehicle for policy analysis A serious monetary policy modelwill include a foreign sector, and it might well deal with the interaction of not justone real and one nominal interest rate, but of the term structure of each linked by

a term structure of inflation expectations It will also take account of complicateddistributed lag relations among its variables Setting these complications aside,however, the underlying structure looks roughly as follows:

IS curve, and i should be regarded as an exogenous variable whose value is set by

the monetary authorities

There is a paradox here, for this framework seems to have no role for the tity of money! To this observation, there is a standard answer: namely, that money

quan-is implicitly in the model after all Equations (2)–(4) may be supplemented by ademand for money function, and linked to the supply of money by an equilibriumcondition Specifically, one may write

But, since eqn (2) determines p (given some historical starting value), eqn (3) determines y (given that y* is determined outside of this inherently short-run framework), and i is an exogenously set policy variable, this extra equation adds

nothing essential to the model It tells us what the money supply will be, but italso tells us that this variable responds completely passively to the demand formoney, and has no effects on any variable that might interest us.2

3 Money and inflation: Channel(s) of influence

To the extent that the quantity of money’s behaviour is related to that of outputand inflation, however, it seems systematically to lead rather than lag these

variables, even when allowance is made for variations in interest rates That oughtnot to happen if the quantity of money is a purely passive variable, though thereare at least two stories that can reconcile this fact with the foregoing model First,money might indeed be a lagging indicator of output and prices, but the procliv-ity of these variables to follow a cyclical time path might produce misleading appearances Second, forward looking agents might adjust their cash holdings toexpectations about future income and prices before they are realised.

But there is a third, altogether more intriguing, possibility The money supply

might, after all, be one of the variables buried in the vector X of eqn (3), and play

a causative role in the economy.3It is this line of argument that I wish to follow

up in this essay In particular, I shall address what I believe to be the main ing point in getting its relevance accepted, namely, the widely held belief thatthough one might make a plausible case for it in a system in which some mone-tary aggregate, for example the monetary base, is an exogenous variable, this cannot be done when it is some rate of interest that the authorities set

stick-Let us start from the fact, particularly stressed by Brunner and Meltzer, that thebanking system and the general public interact with one another not in one mar-

ket, as conventional textbook analysis of the LM curve assumes, but in two.4It isnot just that the public demands and the banks supply money in a market for cashbalances It is also the case that, on the other side of their balance sheets, thebanks also demand, and the public supplies indebtedness in a market for bankcredit Furthermore, activities in the credit market impinge upon the money mar-ket for two reasons First, the banking system’s balance sheet has to balance, andsecond the public’s supply of indebtedness and demand for money are parts of analtogether broader set of interrelated portfolio decisions These involve not onlypublic and private sector bonds, but claims on, and direct ownership of, producerand consumer durable goods as well

The relevant arguments are most simply developed in the context of an omy in which all banking system liabilities function as money, and that is how

econ-I shall now discuss them, but econ-I shall also argue in due course that the essential features of the case carry over to a more complex system

Consider, then, an economy operating at full employment equilibrium, with astable price level (or more generally, a stable and fully anticipated inflation rate)

in which the banking system is happy with the size of its balance sheet, and bers of the non-bank public are also in portfolio equilibrium In that case, the

mem-real rate of interest must be at its natural level at which the term (y ⫺y*) in

eqn (3) above is zero Now let the central bank lower the nominal and therefore,given the expected inflation rate, the real rate of interest at which it makes high-powered money available to the banks These will then lower the nominaland real rates of interest at which they stand ready to make loans to the non-bankpublic, thus disturbing portfolio equilibria among this last group of agents Theywill wish to increase their indebtedness to the banks, but not, as conventional

analysis of the LM curve would seem to have it, simply to add to their money

holdings.5

As Hawtrey (1919: 40) put it, ‘no-one borrows money in order to keep it idle’.The fall in the interest rate at which the banks offer loans will disturb not just themargin between money balances and other stores of value, but also, and crucially,that between indebtedness to the banking system and desired stocks of durablegoods The non-bank public will, then, be induced to borrow money, not in order

to hold it, but in order to spend it Now, of course, this initial response is captured

in eqn (3) of the simple model with which this paper began which describes thelink between aggregate demand and the (real) rate of interest This effect is onlythe first round consequence of an interest rate cut for spending, however Themoney which borrowers use to buy goods is newly created by the banks, andthough it leaves their specific portfolios as they spend it, it nevertheless remains

in circulation, because it is transferred to the portfolios of those from whom theybuy goods Credit expansion by the banks in response to the demands of borrow-ers, even though it involves transactions that are purely voluntary on both sides,nevertheless leads to the creation of money which no one wants to hold

At first sight this seems paradoxical, but money is, above all, a means ofexchange, and what we call the agent’s demand for money does not represent afixed sum to be kept on hand at each and every moment, but rather the averagevalue of an inventory around which actual holdings for the individual will fluctu-ate in the course of everyday transactions In a monetary economy, the typical sale

of goods and services in exchange for money is not undertaken to add nently to money holdings, but to obtain the wherewithal to make subsequent pur-chases of other goods and services Only at the level of the economy as a wholewill fluctuations in individual balances tend to cancel out However if we startwith a situation in which everyone’s money holdings are initially fluctuatingaround a desired average value, so that, in the aggregate, the supply of moneyequals the demand for it, the consequence of an injection of new money into cir-culation will be the creation of a discrepancy at the level of the economy as awhole between the amount of money that has to be held on average and theamount that agents on average want to hold, an economy wide disequilibriumbetween the aggregate supply and demand for money

perma-The consequence of this disequilibrium must be that, again on average, agentswill increase their cash outlays in order to reduce their holdings of money For theindividual agent the destination of a cash outlay undertaken for this purpose is irrel-evant to its accomplishment That agent buys something, or makes a loan, or paysoff a debt to another agent, or pays off a debt to a bank, and gets rid of surplus cash

in each case From the perspective of the economist looking at the economy as awhole, however, the agent’s choice of transaction, and hence the destination of thecash outlay, is crucial Specifically, if that destination is a bank, as it would be, forexample, if the agent decided that the most advantageous transaction available was

to pay off a loan, excess cash is removed from circulation If, on the other hand, thetransaction is with another non-bank agent, portfolio disequilibrium is shifted tosomeone else In the first case the economy’s money supply is reduced, and in thesecond case it remains constant, and hence has further consequences

In principle, either type of response can dominate the second-round effects of acut in the rate of interest, but with very different implications for the transmissionmechanism of monetary policy If, predominantly, money disappears from circu-lation at this stage, as bank debts are reduced, the overall consequences for aggre-gate demand of a cut in interest rates are dominated by the response of output to adiscrepancy between the actual and natural rate of interest, the effect captured by

the parameter h in eqn (3) If it mainly remains in circulation, however, portfolio

disequilibria will persist, as will their effects on expenditure, until some argument

of the demand for money function, the price level say, moves to adjust the demandfor nominal money to its newly increased supply

Let us refer to the first-round effects of the interest rate cut as working through

a credit channel and the second and subsequent round effects as working through

a money channel.6Let us also agree that, in general, monetary policy can workthrough both channels, and that in particular times and places one or the othermight dominate Milton Friedman (e.g 1992, chapter 2) has frequently assertedthat no matter how money gets into circulation, its effects are essentially thesame, that the method of its introduction makes, at the most, a small differenceand only at the first round In terms of the foregoing discussion, he should beinterpreted as asserting that, as an empirical matter, the money channel dominatesthe transmission mechanism On the other hand, in the model which KnutWicksell (1898, chapter 9) used as the formal basis for expounding his pure crediteconomy, the bank deposits created at the beginning of the period of production,which is also the period for which bank loans are granted, all find their way intothe hands of agents for whom the best course of action is to extinguish bank debt

at the end of the period In Wicksell’s model, therefore, the credit channel is theonly one at work

It should now be clear why the existence of a complex modern banking systemwhose liabilities include many instruments that one would be hard put to classify

as ‘money’, particularly if one takes the means of exchange role as being one of

its important defining characteristics, makes no qualitative difference to the

argu-ments that have been presented so far If the money channel of the transmissionmechanism is weak in a particular economy, that must be because individualagents who find themselves with excess cash typically transact with the bankingsystem in order to rid themselves of it, and thereby reduce the money supply Inthe simplest form of system in which all bank liabilities are means of exchange,this possibility already exists because agents have the option of paying off bankloans A more complicated system provides them with more options whereby, inreducing their own cash balances, they also reduce the economy’s money supply

It permits them to purchase and hold a variety of non-monetary bank liabilities.The richness of the menu of liabilities that a modern banking system offers to thepublic thus makes it more plausible to argue that the credit channel is likely todominate monetary policy’s transmission mechanism, but it does not make such

an outcome empirically certain by any means Indeed, the availability of such bilities may only prolong, rather than eliminate, the working out of the money

lia-channel, because non-monetary bank liabilities are, among other things, convenientparking places for excess liquidity, pending the formulation of plans to spend it.7Now the foregoing discussion has been carried on in terms of an experiment inwhich equilibrium is disturbed by a policy action, by the central bank loweringthe nominal and therefore, given inflation expectations, the real interest rate too.But equilibrium can also be disturbed by shocks to the natural rate of interest.Productivity shocks, or fluctuations in what Keynes called the ‘animal spirits’ ofthe business community, to cite two examples, can create a gap between the mar-ket and natural rates of interest and lead on to credit creation and money supplyexpansion just as surely as can policy engineered cuts in the market rate Factors

such as these are buried in the vector X of eqn (3) above This consideration

sug-gests that the workings of the money channel of the transmission mechanism canamplify, even dominate, not only the consequences of monetary-policy-induceddisequilibria for private sector expenditure, but also the consequences of disequi-libria whose origins lie elsewhere Closely related, it also helps to explain the tendency of money to lead real income and inflation even in a world in which expenditure decisions are clearly subject to real disturbances originating outside

of the monetary system

4 Empirical evidence

Now it is appropriate to ask whether there is any reason to believe that the moneychannel as I have described it has any empirical significance Here, I believe, theanswer can be a guarded ‘yes’ Lastapes and Selgin (1994), for example, havenoted that, were nominal money a passively endogenous variable, always adjust-ing to changes in the demand for it, one would expect shocks to the time path of real balances overwhelmingly to originate in shocks to the price level.Fluctuations in the nominal quantity of money would usually appear as equili-brating responses to changes in variables determining the demand for nominalmoney, rather than as factors creating disequilibria in their own right But,analysing United States data for M2 over the period 1962–90, when many wouldargue that money was indeed a passively endogenous variable, they found thatshocks to the nominal quantity of money were an important source of fluctuations

in its real quantity

In a slightly later study, Scott Hendry (1995) has analysed the nature of theerror correction mechanisms underlying fluctuations of Canadian M1 around aco-integrating relationship that he interprets (quite conventionally and uncontro-versially) as a long-run demand-for-money function Were nominal money apurely passive variable in the system, one would expect to see these mechanismsdominated by movements in its quantity, as agents attempt to move back to equi-librium after a disturbance by transacting with the banking system If, on the otherhand, they transact with one another to a significant extent, and hence fail toremove excess nominal money balances from circulation, one would expect to seethe return to a long-run equilibrium level of real money holdings also reflected in

changes in the price level In fact, as Hendry shows, both mechanisms seem to be

at work

These results, however, do not help us to understand just what maximisingchoices they are that determine how much excess money falls into whose handswhen, and what their best response is actually going to be There is a gap in theanalysis here, which, I suspect, it has only recently become technically feasible tofill.8Specifically, I conjecture that recent developments in dynamic general equi-librium modelling provide a technical means of introducing some much-neededclarity here The models in question, as they currently exist, are capable of deal-ing with interactions among the monetary authorities, a banking system, firmsand households, in a framework that pays explicit attention to the timing of spe-cific transactions between pairs of agents and the information available whendecisions are made and acted upon, and also permits the imposition of a widevariety of restrictions on these activities which can significantly affect the econ-omy’s behaviour Thus when participation in credit markets is limited to banksand firms, monetary policy has consequences by way of liquidity effects; whenmoney wage stickiness is introduced, policy (and other) shocks can have real aswell as purely nominal consequences; and so on.9

It ought to be possible to introduce some simple analysis of the demand formoney by households into such a setup, by making utility a function of real bal-ance holdings as well as consumption and leisure, and to supplement this withsome adjustment cost mechanisms that are capable of producing ‘buffer-stock’effects too Firms too, might be given a demand for money function, perhaps byputting real balances into the productions function And if the banking systemwere permitted to emit more than one type of liability, a further extension of theanalysis to encompass simple portfolio decisions might be accomplished To get

at the tendency of injections of money to remain in circulation, it would also benecessary to introduce some variety among firms and households with regard totheir starting level of indebtedness to the banking system too I am sure it wouldnot be easy to do all this, for if it were, someone would already have done it, butwork along these lines does seem to me to be what is needed to fill the analyticgap to which I have pointed.10

The question naturally arises, however, as to whether such work would beworth the effort I can think of at least three reasons why policy makers might findthese matters of interest

First, it is well known that monetary policy works with long lags Perhapseighteen months seem to elapse before a policy-induced interest rate change undertaken today will have noticeable effects upon the inflation rate Some indi-cator variable, affected by the interest rate change, and in turn affecting aggregatedemand, whose behaviour changes during the interval would surely be very useful Potentially, the behaviour of some monetary aggregate can be the source

of valuable intermediate stage information about the progress of policy, and thebetter understood are the theoretical mechanisms underlying that behaviour, theeasier will it be to extract such information

Second, already a problem in the United States, the United Kingdom andCanada, and soon to be a problem in Euroland too, or so one hopes, the basicframework described in eqns (2)–(4) which underlies inflation targeting policies,has been seriously undermined by its own success Once the real economy hassettled down in the region of full employment, the authorities, like everyone else,necessarily become uncertain about the sign, let alone the magnitude, of that all

important output-gap variable (y ⫺y*) And this, of course, makes the whole

framework set out in eqns (2)–(4) an uncertain basis for future policy A cation to it that found a place for some extra indicator of the stance of policywould be well worth having under these circumstances

modifi-Finally, recall that the foregoing analysis has told us that money responds notjust to policy shocks, but to those originating in the real side of the economy also.Information about the occurrence of the latter, before they have an undue influ-ence on money and prices, is surely of value to any monetary authority seeking

to stabilise the inflation rate

5 Concluding remarks

Now I referred at the outset of this paper to conversations with Victoria Chick thatbegan nearly forty years ago I hope that she will read this paper, and be con-vinced that, even though I have seldom agreed with her in the interim, I was, afterall, usually listening But if she does read it, I am sure she will remind me thatthere is something else that she has been trying to tell me for a long time: namely,that monetary institutions evolve over time, and that the model relevant to mone-tary policy in one time and place seldom remains so for long She will also remind me that the problems that my monetarist colleagues and I have always had

in pinning down a precisely defined monetary aggregate to put at the centre ofour policy prescriptions is, from her point of view, simply the image that thisproblem projects when it is viewed through a monetarist lense

Let me end this chapter, then, by assuring her that I have been listening to this bit

of her argument too, and that the reason it is not dealt with here is that I do not haveanything generally helpful to say about it I can recommend nothing more concrete

to monetary authorities who want to extract information from monetary aggregatesthan careful monitoring of the evolution of the particular financial systems overwhich they preside, and suggest nothing more hopeful than that policy designed inhumble consciousness of weaknesses in its underlying framework is likely to be better formulated than that conceived in confident ignorance of them

Notes

1 This paper draws on arguments developed in a specifically Canadian context in Laidler(1999) It was written during the author’s tenure as Bundesbank Visiting Professor atthe Free University of Berlin in the summer of 2000 It formed the basis of talks given

at the Deutsche Bundesbank, the Universities of Frankfurt, Cologne, Hohenheim, theFree University of Berlin and the German Economic Research Institute, and the many

helpful comments received on those occasions from colleagues too numerous to tion are gratefully acknowledged.

men-2 Charles Goodhart (this volume) complains that academic economists have, from thevery start, been unable to reconcile themselves to the fact that central banks have always controlled interest rates rather than a monetary aggregate, even so narrow anaggregate as the monetary base In my view monetarists treat money as exogenous because of a methodological preference for simplified – sometime ruthlessly so –models adapted to whatever purpose is at hand, with exogenous money models being potentially well adapted to the study of the effects of monetary policy on inflation, andnot out of willful blindness to institutional arrangements

3 There are, of course, many precedents for this postulate in the old literature dealing with real balance effects Recently, Meltzer (1999), Goodhart and Hofman (2000) and Nelson (2000) among others have taken up the issue, as indeed has this author(1999)

4 See Brunner and Meltzer (1993) for a systematic retrospective account of their work

5 Note that I am here describing a sequence of events that takes place after the system isshocked, and out of equilibrium, and hence am presuming a modicum of price sticki-ness Some flexible-price equilibrium models have it that a cut in the nominal rate of interest must lead to a new lower rate of inflation, and so it must if the economy is always in rational expectations equilibrium, but work by Cottrell (1989) and Howitt(1992) suggests that consideration of mechanisms of the type discussed here leads tothe conclusion that the equilibrium in question is likely to be unstable and hence unat-tainable, thus rendering its properties uninteresting for policy analysis

6 Let it be explicitly noted that the credit channel effect as discussed here does not encompass credit rationing effects such as Stiglitz and Weiss (1981) analysed Theseeffects would be complementary to those discussed here

7 Indeed, the fact that narrow monetary aggregates seem to display a longer lead overoutput and inflation than broader aggregates, at least in Canadian data, may be related

to this

8 I do not mean to imply here that this problem has not been noted before On the trary James Davidson has devoted considerable attention to modelling it empirically(see e.g Davidson and Ireland 1990) But, unless I have missed some work, an explic-itly maximising analysis of the underlying theory is yet to be forthcoming

con-9 See Parkin (1con-9con-98) for an exceptionally lucid survey of the body of work I have in mindhere

10 Nelson (2000) has indeed already provided an interesting example of work in thisgenre, designed to show how money, or more specifically the monetary base, can influ-ence aggregate demand even after the effects of changes in a short interest rate havebeen accounted for The key feature of his model is that a long rate of interest affectsboth the demand for money and aggregate demand, so that changes in the quantity ofmoney contain information about this variable over and above that contained in theshort rate Nelson’s model does not investigate the role of the credit market in themoney-supply process upon which the argument of this paper concentrates, and theeffects of money disappear when the long rate is taken explicit account of However, tothe extent that the presence of the long rate of interest reflects in his analysis the ideathat money is substitutable for a broad range of assets, it clearly has an important fea-ture in common with the analysis presented here

References

Brunner, K and Meltzer, A H (1993) Money and the Economy: Issues in Monetary Analysis Cambridge: Cambridge University Press, for the Raffaele Mattioli Foundation.