Working Paper: NBER ID: w1890
Authors: Peter R. Hartley; Carl E. Walsh
Abstract: This paper examines the interaction between the financial and real sectors of the economy within the framework of a stochastic, rational expectation model that distinguishes between inside and outside money. The model also can be used to study the impact of variations in the degree of intermediation, measured by the elasticity of bank deposit supply. In contrast to earlier work which emphasized confusion between monetary and real shocks, we focus on the role played by confusion between inside and outside money and temporary and permanent base money disturbances. Financial sector disturbances, as well as temporary shocks tothe monetary base, are shown to have real effects even when private agents have complete information. When contemporaneous information on economic disturbances is incomplete, permanent shocks to the monetary base also have real effects. If our model is correct, it is invalid to reject equilibrium models of the business cycle on the grounds that anticipated money affects output. We argue that this result is robust in the sense that many "reasonable" models which incorporate inside money would yield a non-neutrality of portfolio and temporary base money supply shocks.
Keywords: monetary policy; inside money; outside money; financial intermediation
JEL Codes: E40; E51; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| shocks to inside money (E51) | different effects compared to outside money (E51) |
| permanent shocks to the monetary base (E50) | real effects if confused with temporary shocks (E32) |
| Temporary shocks to the monetary base (E59) | changes in output (E23) |
| Temporary shocks to the monetary base (E59) | changes in prices (E30) |
| Temporary shocks to the monetary base (E59) | real interest rates (E43) |
| anticipated money supply changes (E41) | correlated output movements (C10) |