How justified is abandoning money in the conduct of monetary policy in Australia on the grounds of instability in the money‐demand function?

The role of money in the design and conduct of monetary policy has reemerged as an important issue in both advanced and developing economies, especially since the 2007 global financial crisis. A growing body of recent literature suggests that the causal relationship between money supply growth and inflation remains intact across countries and over time and that this relation is not conditional on the stability of the money‐demand function or whether money is endogenous or exogenous. Moreover, critical for a rule‐based monetary policy is the presence of a long‐run stable money‐demand function, rather than a short‐run money‐demand model that may exhibit instability for many reasons, including problems with estimating a money‐demand model with high‐frequency data. Provided that a stable money‐demand function exists, it could be useful to establish long‐run equilibrium relations among money, output, prices, and exchange rates, as the classical monetary theory suggests. Within this analytical framework, this paper addresses the question of whether money has any role in the conduct of monetary policy in Australia. The conventional wisdom is that the money‐demand function in Australia has been unstable since the mid‐1980s due to financial deregulation and reforms; this led to a change in the strategy of monetary policy for price stability in the form of inflation targeting that ignores money insofar as inflation and its control are concerned. This paper reports empirical findings for Australia, obtained from a longer quarterly data series over the period 1960Q1–2015Q1, which suggest that instability in the narrow‐money‐demand function in Australia was primarily due to the exclusion of variables which have become important in the deregulated environment since the 1980s. These findings are confirmed by an expanded form of the narrow‐money‐demand function that was found stable over the past two decades, although it experienced multiple structural breaks over the study period. The paper draws the conclusion that abandoning the monetary aggregate as an instrument of monetary policy in Australia, under a rule‐based monetary policy such as inflation targeting, cannot be justified by instability in the money‐demand function or even by lack of a causal link between money supply growth and inflation.     

混沌理论在我国货币政策制定和执行中的应用

我国货币政策环境可视作混沌的复杂系统。混沌理论表明,系统在时空上的复杂结构通常隐含着简单的决定性准则,一旦这样的准则被发现,管理当局则可以观察或者控制系统内部的复杂状况,以达到预期目标。运用于货币政策的混沌理论,是指将货币政策环境看作是具有高度复杂性和长期行为不可预测性的混沌系统,其中必然隐含着复杂系统内普遍适用的简单决定性准则。如果我们掌握并始终遵循这一准则,就可以观察并控制货币政策环境这一复杂混沌系统,使货币政策目标向预期的方向发展。     

Globalization,Financial Liberalization and the Behavior of the Long Run Money Demand in the Bangladesh Economy

ABSTRACT

The paper estimates the long run demand for money function in the Bangladesh economy using cointegration and the Vector Error Correction Modeling (VECM) technique. The cointegration results suggest that although the process of globalization has shown no significant impact on money demand by the fact that the foreign interest rate is seen as statistically not significant, the financial liberalization has an important impact, reflected in the statistically significant role of domestic interest rate, in influencing both M1 and M2 money demand. An estimate of VECMs also reveals the fact that the short run speed of adjustment is moderately influenced by the financial reform measures to establish the long run relation between money balances, income and domestic interest rates. The phenomenon of credit constraint in the context of a developing country has shown no significant role in influencing money demand, which may imply that the stage of financial development is getting higher level in the Bangladesh economy. The existence of exchange rate depreciation in the cointegration relation with the expected sign suggests that currency substitution is now effective in the monetary sector and, therefore, its impact should be considered in the Bangladesh monetary policy matrix.     

The nature and role of monetary policy when money is endogenous

This paper considers the nature and role of monetary policywhen money is modelled as credit money endogenously createdwithin the private sector. There are currently two schools ofthought that view money as endogenous: one has been labelledthe ‘new consensus’ in macroeconomics, and the otheris the Keynesian endogenous (bank) money approach. The paperfirst explores the analysis of monetary policy in the ‘newconsensus’ macroeconomic model, followed by an examinationof the effectiveness of monetary policy in that analysis. TheKeynesian view of endogenous money is discussed, and the rolefor monetary policy in a Keynesian endogenous monetary policyanalysis is considered, including discussion of the objectivesand instruments of monetary policy.     

Data uncertainty and the role of money as an information variable for monetary policy

In this study, we perform a quantitative assessment of the role of money as an indicator variable for monetary policy in the euro area. We document the magnitude of revisions to euro area-wide data on output, prices, and money, and find that monetary aggregates have a potentially significant role in providing information about current real output. We then proceed to analyze the information content of money in a forward-looking model in which monetary policy is optimally determined subject to incomplete information about the true state of the economy. We show that monetary aggregates may have substantial information content in an environment with high variability of output measurement errors, low variability of money demand shocks, and a strong contemporaneous linkage between money demand and real output. As a practical matter, however, we conclude that money has fairly limited information content as an indicator of contemporaneous aggregate demand in the euro area.     

A macroeconometric framework for monetary policy evaluation: A case study of Pakistan

This paper attempts to establish the quantitative importance of the various channels of monetary transmission by constructing, estimating and simulating a small macroeconometric model of Pakistan's monetary sector, while using data from the monetary statistics and the monetary survey of the State Bank of Pakistan over 1976–2007. The paper elucidates that the key feature of the study of monetary policy in Pakistan has been preoccupied with neglect either of the demand or the supply function of money and shows how this may lead to imprecise policy actions and mistaken conclusions. Accordingly, we delineate the transmission mechanism of monetary policy by taking into consideration all structural money demand and money supply linkages along with the historically implied identifying assumption in the framework of a marginalized macroeconometric model. The within-sample and out-of-sample evaluations of the model are found satisfactory. The paper presents results of three policy simulations from the estimated model that highlight the impact of alternative monetary policy instruments on the monetary variables under a rule-based and a discretionary policy environment. We find that (i) the SBP subscribes to an unannounced monetary policy rule, (ii) the determination of the policy rate under the announced rule environment stabilizes the monetary sector in that convergence to full equilibrium is smooth and rapid, (iii) a 100 bps reduction in the discount rate, ceteris paribus, decreases money supply by 4.97%, and (iv) the long term implication of reducing (increasing) the reserve requirement ratio on time (demand) deposits, ceteris paribus, is only higher inflation. Finally, we establish that a 100 bps increase in interest rate increases money supply by 3.14% in full equilibrium.     

Should Banks Be Banned From Creating Money? An Analysis From the Perspective of Hierarchical Money

We extend the concept of “hierarchy of money” to our current monetary and financial system based on fiat money, with monetary policy that is conducted through the sale and purchase of securities and credit intermediation by non-bank financial intermediaries. This exposes a feedback loop between the upper and lower level of the hierarchy, which allows for more than full use of otherwise dormant capital, but that also increases inherent instabilities manifested in asset booms and busts. From the perspective of hierarchical money, we find that the call to ban banks from creating money neglects the significant role of securities-based financing in the global financial markets at the lower level, as well as the money creation capacity of central banks at the highest level of the hierarchy. Moreover, the inherently expansive nature of the hierarchy of money contradicts the long-term feasibility of full-reserve banking.     

Money-Hoarding as a Behaviour Towards Uninsured Idiosyncratic Risk

This paper explores the implications of the presence of uninsured idiosyncratic risks for the hoarding of intrinsically useless fiat money in an overlapping-generations model. It is shown that: (a) monetary equilibria exist in almost all cases; (b) the valuation of money is not necessarily Pareto-improving since the non-monetary steady state may Pareto-dominate the monetary one; and (c) the accelerating inflation may, moreover, reduce the long-run capital stock.
JEL Classification Number: E41.     

The impact of economic and monetary uncertainty on the demand for money in emerging economies

By introducing uncertainty, monetary volatility and economic volatility are said to make the public cautious, hence increase their cash holdings or their demand for money. On the other hand, because of monetary and economic uncertainty if the public seek safer assets than money, they may hold less cash. In the absence of any paper testing for the impact of economic and monetary uncertainty on the demand for money in emerging economies, this article fills the gap by considering the experiences of six Central and Eastern European emerging economies and four other emerging economies. We found that the impact is transitory in most countries. Moreover, money demand is found correctly specified and stable in most countries, suggesting that policy based on monetary targeting could still be effective despite significant output and monetary uncertainty.     

Existence of a monetary steady state in a matching model: divisible money

Existence of a monetary steady state is established in a random matching model with divisible goods, divisible money, an arbitrary bound on individual money holdings, and take-it-or-leave-it offers by consumers. The monetary steady state shown to exist has nice properties: the value function, defined on money holdings, is strictly increasing and strictly concave, and the distribution over money holdings has full support. The approach is to show that the “limit” of the nice steady states for indivisible money, existence of which was established in an earlier paper, as the unit of money goes to zero is a monetary steady state for divisible money. For indivisible money, the marginal utility of consumption at zero was assumed to be large; for divisible money it is assumed to be large and finite.     

Money Quantity and Optimal Monetary and Fiscal Policy: A Quantitative Analysis

This paper quantitatively analyzes the impact of money stock on optimal monetary and fiscal policy in a stochastic production economy with sticky prices. The numerical results indicate that a sufficient large quantity of money makes a noticeable difference in many aspects of optimal monetary and fiscal policy. They suggest that the volatile inflation in China may not be as bad as the existing theory would have implied if its large amount of money is taken into consideration.     

A two-pillar DSGE monetary policy model for the euro area

The current financial crisis has revived the interest for monitoring both monetary and credit developments. Over the past two decades, consistent with the adoption of inflation targeting strategies by a growing number of central banks and the development of New Keynesian models for which monetary aggregates are largely irrelevant, money and credit have been progressively neglected in the conduct of monetary policy. A striking exception has been the Eurosystem, which has implemented a strategy known as the “two-pillar monetary policy strategy” giving a prominent role for money. In this paper, we develop a small optimizing model based on Ireland (2004), estimated on euro area data and featuring this two-pillar strategy. We evaluate an ECB-style cross-checking policy rule in a DSGE model with real balance effects of money. We find some evidence that indeed money plays a non-trivial role in explaining the euro area business cycle. This provides a rationale for the central bank to factor in monetary developments but also raises some issues regarding the reliability of M3 as an appropriate monetary indicator. We find some evidence that the ECB has systematically reacted to a filtered measure of money growth but weak evidence it has reacted more aggressively during excess money growth periods.     

Stability of Money Demand and Monetary Policy in Papua New Guinea (PNG): An Error Correction Model Analysis

An error correction model (ECM) is used to study the Properties of money demand and to evaluate the appropriate monetary policy in PNG. The study confirms that the determinats of money demand are real GDP, nominal interest and inflation rate. The income elasticity of money demand is very low. The demand for money in PNG was stable during 1979-95, suggesting that the monetary targeting regime by the PNG Central Bank is feasible. However, as PNG proceeds with economic reforms that Includes financial sector reform and a floating exchange rate regime, the stability of the demand for money may have to be re-examined periodically. The best approach for conducting the monetary policy in PNG is to target the inflation rate. [E41, E52, C22]     

Endogeneity in European money demand

European wide monetary aggregates constructed from pre-unification data cannot be used as evidence that money demand in the euro area is stable. To overcome the Lucas critique, we apply the standard foreign exchange rate model. Since the uncoordinated country specific money supply system is abolished, the increased comovement between local monetary aggregates leaves little room for a free ride on the law of large numbers. Current monetary policy decisions must be based on untested relations, and given ‘the long and variable lags’, we conclude that the road towards monetary stability is a non-activist steady money supply policy.     

The theory of fiat money and private money as alternative media of exchange

A random-matching model with a clearinghouse is constructed to investigate the impact of private money on economic efficiency and social welfare in three monetary regimes. A subset of agents, called bankers, whose credit histories are recorded by the clearinghouse, are allowed to issue private banknotes in order to consume. Those private liabilities may serve as media of exchange, either by themselves, or alongside a stock of fiat money. Under certain conditions, welfare in a monetary steady state with private money is strictly higher than that attained in a steady state where private money is prohibited.     

Exchange rate regimes and inflation: only hard pegs make a difference

Abstract.  Using data from a large sample of developing countries from 1985 to 2001, we confirm that hard pegs (currency boards or a shared currency) reduce inflation and money growth. There is no evidence that soft pegs confer any monetary discipline, after other factors are controlled for. Inflation triggers regime switches. Under hard pegs, monetary growth is unaffected by fiscal deficits or by inflation shocks. Under soft pegs, as under floats, increased fiscal deficits and positive inflation shocks are associated with higher monetary growth. The apparently slower per capita output growth under hard pegs is explained by their geographical distribution. JEL classification: F41     

Financial market imperfections and monetary policy strategy

In a model with imperfect money, credit and reserve markets, we examine if an inflation-targeting central bank applying the funds rate operating procedure to indirectly control market interest rates also needs a monetary aggregate as policy instrument. We show that if private agents use information extracted from money and financial markets to form inflation expectations and if interest rate pass-through is incomplete, the central bank can use a narrow monetary aggregate and the discount interest rate as independent and complementary policy instruments to reinforce the credibility of its announcements and the role of inflation target as a nominal anchor for inflation expectations. This study shows how a monetary policy strategy combining inflation targeting and monetary targeting can be conceived to guarantee macroeconomic stability and the credibility of monetary policy. Friedman's k-percent money growth rule, which can generate dynamic instability, and two alternative stabilizing feedback monetary targeting rules are examined.     

Money Creation in the Eurozone: An Empirical Assessment of the Endogenous and the Exogenous Money Theories

ABSTRACT

The aim of this paper is to strengthen our understanding of the money creation process in the Eurozone for 1999–2016 period, through an empirical assessment of two main monetary theories, namely the (Post Keynesian) endogenous money theory and the (Monetarist) exogenous money theory. By applying a VAR and VECM methodology, we analyse the causal relationship among monetary reserves (or monetary base), bank deposits and bank loans. Our empirical analysis supports several propositions of the Post Keynesian endogenous money theory since (i) bank loans determine bank deposits, and (ii) bank deposits in turn determine monetary reserves.     

Global slack hypothesis: evidence from China,India and Pakistan

It is widely believed that globalization has changed inflation process. The global resource capacity reduces responsiveness of inflation to domestic activity and increases responsiveness of inflation to global resource capacity. This global slack hypothesis is tested using different theoretical specifications, which also relate domestic output elasticity and foreign output elasticity to the degree of trade openness of an individual economy. The results reject this hypothesis. The global resource capacity does not drive domestic inflation. The impact of globalization has not increased in the inflation process, and the results yield important policy implications for monetary policy formulation. The global resource capacity does not affect ability of the central banks to stabilize inflation, real economic activity and also respond to the volatility of output growth.     

THE DISTRIBUTION OF MONEY BALANCES AND THE NONNEUTRALITY OF MONEY*

Recent monetary models with explicit microfoundations are made tractable by assuming that agents have access to centralized markets after one round of decentralized trade. Given quasi‐linear preferences, this makes the distribution of money degenerate—which keeps the models simple but precludes the discussion of distributional effects of monetary policy. We generalize these models by assuming two rounds of trade before agents can readjust their money holdings to study a range of new distributional effects analytically. We show that unexpected, symmetric lump‐sum money injections may increase short‐run output and welfare, whereas asymmetric injections may increase long‐run output and welfare.