On the Purchasing Power of Money in an Exchange Economy

Radwanski, Juliusz (2020): On the Purchasing Power of Money in an Exchange Economy.

Abstract

A model is constructed in which completely unbacked fiat money, issued by generic supplier implementing realistically specified monetary policy designed to obey certain sufficient conditions, is endogenously accepted by rational individuals at uniquely determined price level. The model generalizes Lucas (1978) to an economy with frictions and specialization in production, without imposing the cash-in-advance constraint. The uniqueness of equilibrium is the consequence of complete characterization of both the environment, and the equilibrium concept. The results challenge the doctrine that equilibria of monetary economies are inherently indeterminate, and that money can become worthless only due to self-fulfilling expectations. The paper shows that monetary policy canonically features two dimensions, one of which corresponds to nominal interest rate, and the other to continuous helicopter drop of net worth, which in the model takes the form of universal basic income.

• Item Type: MPRA Paper
• Language: English
• Keywords: fiat money, monetary policy, Hahn problem, price level, inflation, sunspots, helicopter drop, universal basic income
• Subjects: E - Macroeconomics and Monetary Economics > E1 - General Aggregative Models > E10 - General; E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E31 - Price Level ; Inflation ; Deflation; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E41 - Demand for Money; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E51 - Money Supply ; Credit ; Money Multipliers; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E58 - Central Banks and Their Policies; G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing ; Trading Volume ; Bond Interest Rates; G - Financial Economics > G2 - Financial Institutions and Services > G21 - Banks ; Depository Institutions ; Micro Finance Institutions ; Mortgages

References

Aiyagari, Rao S. (1994), “Uninsured idiosyncratic risk and aggregate saving.” Quarterly Journal of Economics, 109, 659–684.

Alchian, Armen A. (1977), “Why money?” Journal of Money, Credit and Banking, 9, 133–140.

Altug, Sumru and Pamela Labadie (2008), Asset pricing for dynamic economies. Cambridge University Press.

Bagehot, Walter (1873), Lombard Street: a Description of the Money Market. Henry S. King & Company 65 Cornhill & 12 Paternoster Row.

Benigno, Pierpaolo and Salvatore Nisticò (2020), “The economics of helicopter money.” Technical report, CEPR Discussion Paper No. 14555.

Berge, Claude (1963), Topological spaces. Oliver and Boyd.

Bernanke, Ben (2002), “Deflation: Making sure it does not happen here.” Remarks by Governor Ben Bernanke Before the National Economists Club Washington, DC.

Bernanke, Ben (2003), “Some thoughts on monetary policy in Japan.” Remarks before the Japan Society of Monetary Economics, Tokyo.

Bewley, Truman (1977), “The permanent income hypothesis: A theoretical formulation.” Journal of Economic Theory, 16, 252–292.

Blanchard, Olivier J. and Stanley Fischer (1989), Lectures on Macroeconomics. MIT Press.

Boud, John H. III (1990), “Recursive utility and the Ramsey problem.” Journal of Economic Theory, 50, 326–345.

Brock, William A. (1974), “Money and growth: The case of long run perfect foresight.” International Economic Review, 750–777.

Brunner, Karl and Allan H. Meltzer (1971), “The uses of money: Money in the theory of an exchange economy.” American Economic Review, 61, 784–805.

Buiter, Willem H. (2002), “The fiscal theory of the price level: A critique.” Economic Journal, 112, 459–480.

Buiter, Willem H. (2014), “The simple analytics of helicopter money: Why it works – always.” Economics, 8.

Christiano, Lawrence J. and Terry J. Fitzgerald (2000), “Understanding the fiscal theory of the price level.” Economic Review, 36, 2–37.

Clarida, Richard, Jordi Galı́, and Mark Gertler (2000), “Monetary policy rules and macroeconomic stability: Evidence and some theory.” Quarterly Journal of Economics, 115, 147–180.

Cochrane, John H. (2011), “Determinacy and identification with taylor rules.” Journal of Political Economy, 119, 565–615.

Cochrane, John H. (2018), “Michelson-Morley, Fisher, and Occam: The radical implications of stable quiet inflation at the zero bound.” NBER Macroeconomics Annual, 32, 113–226.

Fisher, Irving (1911), The purchasing power of money. Macmillan. Assisted by H. G. Brown.

Friedman, Milton (1956), “The quantity theory of money: A restatement.” Studies in the quantity theory of money, 5, 3–31.

Friedman, Milton (1969), “The optimum quantity of money.” In The optimum quantity of money, and other essays, Adline Publishing Company.

Galı́, Jordi (2015), Monetary policy, inflation, and the business cycle: An introduction to the new Keynesian framework and its applications. Princeton University Press.

Galı́, Jordi (2020), “The effects of a money-financed fiscal stimulus.” Journal of Monetary Economics (forthcoming).

Grandmont, Jean-Michel and Guy Laroque (1973), “Money in the pure consumption loan model.” Journal of Economic Theory, 6, 382–395.

Hahn, Frank H. (1965), On some problems of proving the existence of an equilibrium in a monetary economy. Macmillan.

Harrison, J. Michael and David M. Kreps (1979), “Martingales and arbitrage in multiperiod securities markets.” Journal of Economic Theory, 20, 381–408.

Hellwig, Martin F. (1993), “The challenge of monetary theory.” European Economic Review, 37, 215–242.

Hicks, John R. (1935), “A suggestion for simplifying the theory of money.” Economica, 2, 1–19.

Howitt, Peter (2003), “Comment on ”Search, Money, and Capital: A Neoclassical Dichotomy” by S. Borağan Aruoba and Randall Wright.” Journal of Money, Credit and Banking, 1107–1110.

Howitt, Peter (2005), “Beyond search: Fiat money in organized exchange.” International Economic Review, 46, 405–429.

Jevons, William S. (1875), Money and mechanism of exchange. D. Appleton & Co.

Keynes, John Maynard (1930), A Treatise on money (2 Vols). Macmillan.

Kiyotaki, Nobuhiro and Randall Wright (1989), “On money as a medium of exchange.” Journal of Political Economy, 97, 927–954.

Kocherlakota, Narayana R. (1998), “Money is memory.” Journal of Economic Theory, 81, 232–251.

Kocherlakota, Narayana R. and Christopher Phelan (1999), “Explaining the fiscal theory of the price level.” Federal Reserve Bank of Minneapolis Quarterly Review, 23, 14–23.

Kohn, Meir (1988), “The finance constraint theory of money: A progress report.” The Jerome Levy Economics Institute Working Paper.

Lagos, Ricardo and Randall Wright (2005), “A unified framework for monetary theory and policy analysis.” Journal of Political Economy, 113, 463–484.

Leeper, Eric M. (1991), “Equilibria under ’active’ and ’passive’ monetary and fiscal policies.” Journal of Monetary Economics, 27, 129–147.

Lucas, Robert E. (1972), “Expectations and the neutrality of money.” Journal of Economic Theory, 4, 103–124.

Lucas, Robert E. (1978), “Asset prices in an exchange economy.” Econometrica, 1429–1445.

Matsuyama, Kiminori (1991), “Endogenous price fluctuations in an optimizing model of a monetary economy.” Econometrica, 1617–1631.

Menger, Karl (1892), “On the origins of money.” Economic Journal, 2, 239–255.

Modigliani, Franco and Merton H. Miller (1958), “The cost of capital, corporation finance and the theory of investment.” American Economic Review, 48, 261–297.

Niepelt, Dirk (2004), “The fiscal myth of the price level.” Quarterly Journal of Economics, 119, 277–300.

Obstfeld, Maurice and Kenneth Rogoff (1983), “Speculative hyperinflations in maximizing models: Can we rule them out?” Journal of Political Economy, 91, 675–687.

Patinkin, Don (1965), Money, interest, and prices; an integration of monetary and value theory.

Robertson, Dennis H. (1933), “Saving and hoarding.” Economic Journal, 43, 399–413.

Samuelson, Paul A. (1958), “An exact consumption-loan model of interest with or without the social contrivance of money.” Journal of Political Economy, 66, 467–482.

Sargent, Thomas J. (2015), “Robert E. Lucas Jr.’s collected papers on monetary theory.” Journal of Economic Literature, 53, 43–64.

Sargent, Thomas J. and Neil Wallace (1981), “Some unpleasant monetarist arithmetic.” Federal reserve bank of Minneapolis quarterly review, 5, 1–17.

Shi, Shouyong (1995), “Money and prices: A model of search and bargaining.” Journal of Economic Theory, 67, 467–496.

Sims, Christopher A. (1994), “A simple model for study of the determination of the price level and the interaction of monetary and fiscal policy.” Economic Theory, 4, 381–399.

Taylor, John B. (1993), “Discretion versus policy rules in practice.” In Carnegie-Rochester Conference Series on Public Policy, volume 39, 195–214.

Tobin, James (1958), “Liquidity preference as behavior towards risk.” Review of Economic Studies, 25, 65–86.

Townsend, Robert M. (1980), “Models of money with spatially separated agents.” In Models of Monetary Economies (Kareken J. H. and Wallace N., eds.), 265–303, Federal Reserve Bank of Minneapolis.

Trejos, Alberto and Randall Wright (1995), “Search, Bargaining, money, and prices.” Journal of Political Economy, 103, 118–141.

Wallace, Neil (1980), “The overlapping generations model of fiat money.” In Models of Monetary Economies (Kareken J. H. and Wallace N., eds.), 49–82, Federal Reserve Bank of Minneapolis.

Walras, Léon (1900), Elements of pure economics. Homewood. Translated from French by William Jaffé (1954).

Woodford, Michael (1995), “Price-level determinacy without control of a monetary aggregate.” In Carnegie-Rochester conference series on public policy, volume 43, 1–46.

Woodford, Michael (2003), Interest and prices. Princeton University Press.