Inflation Theory in Economics

Description

These essays bring together a progression in monetary theory. The major theme that runs through all of the chapters is that in order to do monetary economics well in general equilibrium, it helps to have a good money demand underlying the theory.

A proper underlying money demand sets up arguably the best foundation from which to make extensions of monetary economics from the basic model. At the same time that money demand is modelled, this also “endogenizes” the velocity of money. This has been a challenge in the literature that these essays solve and then use to extend basic neoclassical growth and business cycle theory. Solving this problem, in a way that is a natural, direct, and “micro-founded” extension of the standard monetary theory is the first major contribution of the collection. The second major contribution is the extension of the neoclassical monetary models, using this solution, to reinvigorate classic issues of monetary economics and take them to the frontier.

Cover 2
Inflation Theory in Economics: Welfare, velocity, growth and business cycles 7
Copyright 7
Contents 9
Figures 15
Tables 17
Contributors 19
Preface 20
1 Overview 21
- 1.1 Inflation and welfare 24
- 1.2 Money demand and velocity 28
- 1.3 Inflation and growth 30
- 1.4 Monetary business cycles 33
Part I Inflation and welfare 35

Cover 2
Inflation Theory in Economics: Welfare, velocity, growth and business cycles 7
Copyright 7
Contents 9
Figures 15
Tables 17
Contributors 19
Preface 20
1 Overview 21
- 1.1 Inflation and welfare 24
- 1.2 Money demand and velocity 28
- 1.3 Inflation and growth 30
- 1.4 Monetary business cycles 33
Part I Inflation and welfare 35
- 2 The welfare costs of inflation in a cash-in-advance model with costly credit 37
  - 2.1 Introduction 37
  - 2.2 The deterministic costly credit economy 39
  - 2.3 Discussion of first-order conditions 42
  - 2.4 Substitution rates in the cash-in-advance economies 43
  - 2.5 The welfare costs of stable inflation 44
  - 2.6 Comparison of the interest elasticities of money demand 46
  - 2.7 Estimates of welfare costs and elasticities 48
  - 2.8 Qualifications 50
  - Appendix 2.A: stationary equilibrium solution 50
  - Appendix 2.B: parameter specification and data description 51
- 3 A comparison of partial and general equilibrium estimates of the welfare cost of inflation 54
  - 3.1 Introduction 54
  - 3.2 Partial equilibrium differences 55
  - 3.3 Partial versus general equilibrium 60
  - 3.4 General equilibrium differences 64
  - 3.5 Conclusion 65
- 4 The optimality of a zero inflation rate: Australia 67
  - 4.1 Introduction: menu costs and suboptimality of the Friedman deflation 67
  - 4.2 Economy with costly inflation adjustment: reducing the real wage 69
  - 4.3 The effect of menu costs on the equilibrium 72
  - 4.4 The cost of inflation with the adjustment cost 73
  - 4.5 Alternative adjustment cost functions 76
  - 4.6 Conclusions and qualifications 78
- 5 On the optimality of restricting credit: inflation-avoidance and productivity 82
  - 5.1 Introduction 82
  - 5.2 The economy with an explicit financial intermediation sector 84
  - 5.3 Levelling the inflation distortion through credit taxes 87
  - 5.4 Restricting credit when it has other benefits 91
  - 5.5 Endogenous growth and the credit tax 94
  - Appendix 5.A: base model 96
  - 5.6 Conclusion 96
  - Appendix 5.B: endogenous growth 97
- 6 Ramsey-Friedman optimality with banking time 100
  - 6.1 Introduction 100
  - 6.2 The “banking time” economy 102
  - 6.3 Equilibrium 107
  - 6.4 The Ramsey optimum 112
  - 6.6 Conclusion 115
  - 6.5 Discussion 115
  - Appendix 6.A: derivation of equations 116
- Part II Money demand and velocity 119
  - 7 The demand for bank reserves and other monetary aggregates 121
    - 7.1 Introduction 121
    - 7.2 Sensitivity to lump transfers 122
    - 7.3 Models of monetary aggregates 124
    - 7.4 Changes in aggregates over time 134
    - 7.5 Discussion 141
  - 8 Money velocity with costly credit 147
    - 8.1 Introduction 147
    - 8.2 The representative agent economy 149
    - 8.3 Data 156
    - 8.4 Results 157
    - 8.5 Conclusion 165
    - Appendix 8.A: first-order conditions of equilibrium 167
    - Appendix 8.B: additional estimation details 168
  - 9 Money demand in general equilibrium endogenous growth: Estimating the role of a variable interest elasticity 170
    - 9.1 Introduction 170
    - 9.2 Representative agent economy 171
    - 9.3 Econometric model specification 177
    - 9.4 Data 178
    - 9.5 Results 179
    - 9.6 Robustness 183
    - 9.7 Discussion 187
    - 9.8 Conclusion 188
    - Appendix 9.A: data description 189
  - 10 Money demand in an EU accession country: A VECM Study of Croatia 191
    - 10.1 Introduction 191
    - 10.2 Croatian money, policy and banking background 194
    - 10.3 Data and descriptive analysis 196
    - 10.4 Econometric modelling 200
    - 10.5 Conclusion 206
  - Part III Inflation and growth 211
    - 11 Inflation and balanced-path growth with alternative payment mechanisms 213
      - 11.1 The economy with goods, human capital and exchange production 216
      - 11.2 Calibration 227
      - 11.3. Comparison to other payment mechanisms 232
      - 11.4 Conclusion 233
      - Appendix 11.A 234
    - 12 Contrasting models of the effect of inflation on growth 238
      - 12.1 Introduction 238
      - 12.2 The general monetary endogenous growth economy 241
      - 12.3 Physical capital only models 246
      - 12.4 Human capital only models 250
      - 12.5 Models with physical and human capital 253
      - 12.6 Comparison of models 257
      - 12.7. Conclusions 258
      - Appendix 12.A: section 12.2 first-order conditions 259
    - 13 A revised Tobin effect from inflation: Relative input price and capital ratio realignments, USA and UK, 1959–1999 262
      - 13.1 Introduction 262
      - 13.2 Endogenous growth, cash-in-advance model 264
      - 13.3 Empirical methodology and results 268
      - Appendix 13.A: description of the data set 272
      - 13.4 Conclusions and qualifications 272
    - 14 Inflation and growth: Explaining a negative effect 274
      - 14.1 Introduction 274
      - 14.2 Endogenous growth monetary framework 277
      - 14.3 The data 283
      - 14.4 The econometric model 284
      - 14.5 Results 285
      - 14.6 Discussion of results 288
      - 14.7 Conclusion 291
    - 15 Granger causality of the inflation–growth mirror in accession countries 294
      - 15.1 Introduction 294
      - 15.2 The model 297
      - 15.4 Empirical results 302
      - 15.3 Data and empirical methodology 302
      - 15.5 Structural breaks in Hungary and Poland 312
      - 15.6 Discussion 315
      - 15.7 Conclusion 317
    - Part IV Monetary business cycles 319
      - 16 Keynes’s Treatise: aggregate price theory for modern analysis? 321
        
        16.1 The Treatise’s theory of the aggregate price 321
        
        16.2 Construction of a Keynesian cross 323
        
        16.3 A qualification about policy from this interpretation 326
        
        16.4 Modification with a neoclassical definition of profit 329
        
        16.5 Total revenue, total cost, and AS-AD analysis 330
        
        16.6 Discussion and comparison of the analysis 333
        
        16.7 Conclusions and qualifications 335
      - 17 Credit shocks in the financial deregulatory era: Not the usual suspects 340
        
        17.1 Introduction 340
        
        17.2 The credit model 342
        
        17.3 Results: the construction of credit shocks 349
        
        17.4 Credit shocks and banking deregulation 353
        
        17.5 Discussion 357
        
        17.6 Conclusions 358
      - 18 A comparison of exchange economies within a monetary business cycle 360
        
        18.1 Introduction 360
        
        18.2 Exchange-based business cycle models 362
        
        18.3 Impulse responses 368
        
        18.4 Puzzles 370
        
        18.5 Sensitivity and robustness 374
        
        18.6 Discussion 376
        
        18.7 Conclusion 377
        
        Appendix 18.A 377
      - 19 Money velocity in an endogenous growth business cycle with credit shocks 381
        
        19.1 Introduction 381
        
        19.2 Endogenous growth with credit 382
        
        19.3 Impulse responses and simulations 386
        
        19.4 Variance decomposition of velocity 389
        
        19.5 Discussion 390
        
        19.6 Conclusion 391
        
        Appendix 19.A: construction of shocks 391
      - 20 Epilogue: The perspective going forward 393
    - Bibliography 397
    - Index 415

Author's affiliation

Max Gillman: Cardiff University, UK

Welfare, Velocity, Growth and Business Cycles

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