Working Paper: CEPR ID: DP569
Authors: Michael J. Moore
Abstract: It is argued that financial innovation, in so far as it affects the technology for carrying out transactions, is endogenous, discrete and irreversible. This observation is developed to provide microfoundations for a type of `liquidity' trap and its implications of this are explored in an intertemporal optimizing macroeconomic model with perfect foresight. The main conclusion is that financial innovation of this kind can lead to co-ordination failure in the financial sector. Consequently changes in the nominal money stock can have real effects. These results are illustrated diagramatically using a novel form of the IS/LM apparatus. The analysis also suggests there may be a connection between instability in the demand for money and the Phillips curve may be connected.
Keywords: innovation; monetary policy; demand for money; islm curve
JEL Codes: 311; 432; 621
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Financial Innovation (G29) | Coordination Failure in the Financial Sector (E44) |
| Coordination Failure in the Financial Sector (E44) | Changes in the Demand for Money (E41) |
| Changes in the Nominal Interest Rate (E43) | Investments in New Technologies (O39) |
| Investments in New Technologies (O39) | Discontinuity in the Demand for Money Function (E41) |
| Fall in the Nominal Money Stock (E49) | Excess Demand for Money (E41) |
| Excess Demand for Money (E41) | Keynesian Underemployment Equilibrium (D59) |
| Financial Innovation (G29) | Real Effects on Income and Consumption (E21) |
| Monetary Policy (E52) | Mitigation of Coordination Failures from Financial Innovation (E44) |