Working Paper: CEPR ID: DP1404
Authors: Jess Benhabib; Roger E. A. Farmer
Abstract: In this paper we take as given that market economies are characterized by a set of stylized responses to increases in the stock of money. Innovations to the stock of money lead to increased output and reductions in short-term interest rates in the short run and only in the long run do nominal prices respond. These features of the monetary transmission mechanism have been discussed at least since David Hume. Most authors have attributed the real effects of money in the short run either to mistaken expectations or to non-market clearing or both. In this paper we argue that neither of these channels is needed to explain the facts. We show that a competitive market clearing model in which money enters the production function is fully capable of mimicking the broad features of the data. Our argument relies on an explanation of ?price stickiness? that exploits a multiplicity of equilibria in a rational expectations model.
Keywords: Sunspots; Indeterminacy; Business Fluctuations
JEL Codes: E00; E4
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| increase in the stock of money (E51) | reduction in short-term interest rates (E43) |
| increase in the stock of money (E51) | increase in output (E23) |
| anticipation of future inflation (D84) | affects current interest rates (E43) |
| anticipation of future inflation (D84) | affects output levels (E23) |
| increase in the stock of money (E51) | anticipation of future inflation (D84) |