Working Paper: CEPR ID: DP4974
Authors: Andreas Schabert; Christian Stoltenberg
Abstract: This paper examines how money demand induced real balance effects contribute to the determination of the price level, as suggested by Patinkin (1949,1965), and if they affect conditions for local equilibrium uniqueness and stability. There exists a unique price level sequence that is consistent with an equilibrium under interest rate policy, only if beginning-of-period money enters the utility function. Real money can then serve as a state variable, implying that interest rate setting must be passive for unique, stable, and non-oscillatory equilibrium sequences. When end-of-period money provides utility, an equilibrium is consistent with infinitely many price level sequences, and equilibrium uniqueness requires an active interest rate setting. The stability results are, in general, independent of the magnitude of real balance effects, and apply also when prices are sticky. In contrast, under a constant money growth policy, equilibrium sequences are (likely to be) locally stable and unique for all model variants.
Keywords: monetary policy rules; predetermined money; price level determination; real balance effects; real determinacy
JEL Codes: E32; E41; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| beginning-of-period money (E42) | unique price level sequence (E30) |
| interest rate policy (passive) (E43) | unique stable equilibrium sequences (C62) |
| end-of-period money (E42) | infinitely many price level sequences (E30) |
| end-of-period money (E42) | nominal indeterminacy (D89) |
| active interest rate policies (E43) | uniqueness of equilibrium (C62) |
| constant money growth policies (O42) | unique locally stable equilibrium sequences (C62) |
| real balance effects (H31) | macroeconomic stability (E60) |