tag:blogger.com,1999:blog-5287527236941482415.post5448273575332619638..comments2017-06-15T18:08:02.660-07:00Comments on John Handley: Monetarism and the Neo-Wicksellian FrameworkJohn Handleynoreply@blogger.comBlogger2125tag:blogger.com,1999:blog-5287527236941482415.post-37951946931209592662017-06-11T06:49:59.779-07:002017-06-11T06:49:59.779-07:00It's not actually a typo; money demand increas...It's not actually a typo; money demand increases in two cases: when there are direct shocks to the LM curve, and when there is a negative shock to the IS curve. If you substitute the IS equation into the LM equation (M/P = aY - br = aY - b/d(c+Y) = (a - b/d)Y -b/dc), you see this. If c falls (which could be because the government cuts spending, consumers are suddenly up against their borrowing constraints, businesses and household revise their expectations of economic growth down significantly, or some other random reason), then the demand for money at full employment is higher.<br /><br />Maybe it would've been better if I posited the money demand curve (all variables in logs) m(t)-p(t) = y(t) - ai(t), and solved it forward for the price level at period t assuming rational expectations and flexible prices (so that y(t) = y and i(t) = r* + pi(t+1)) so that the role of expected permanence in monetary expansions was clear, but I'm skeptical of the extent that rational expectations are consistent with reality and I wanted to keep the math as simple as possible, so I just stuck with static IS-LM.<br /><br />Regarding your old post, I agree with you that the consumption Euler equation in the standard NK model is awful. Aside from the indeterminacy issues you mentioned, it's really empirically inaccurate (http://noahpinionblog.blogspot.com/2014/01/the-equation-at-core-of-modern-macro.html). In terms of deciding whether to use interest rates or money as indicators of monetary policy, I think it's pretty clear neither does the job exceedingly well; the both r* and money demand fluctuate too much, but I like the idea of having a Taylor Rule quantify monetary policy. Of course you could write a rule for how the monetary base behaves, but it wouldn't be simple and it'd be really hard to justify quadrupling the monetary base no matter what the economic conditions are if you're targeting money. I don't like broader measure either, because central banks don't have direct control over M1, let alone M2 or M3. John Handleyhttps://www.blogger.com/profile/16057855086740377031noreply@blogger.comtag:blogger.com,1999:blog-5287527236941482415.post-23739224874202382592017-06-10T12:08:21.037-07:002017-06-10T12:08:21.037-07:00Is there a typo here: "With the LM curve rela...Is there a typo here: "With the LM curve relating real money demand to output and the interest rate, it is clear that shifts in the IS curve are the same thing as higher demand for money at a given interest rate."? Should "shifts in the IS curve" be "shifts in the LM curve"?<br /><br />"If we write the LM curve as M/P = L(Y,r) = aY - br and the IS curve as Y = c - dr, then we can figure out what happens if a recession hits -- in this case that means c falls." Well, a fall in c would be *one* possible cause of a recession, in this model, but changes in a, b, or d could also cause a recession. (Perhaps that's what you meant.)<br /><br />"That might be really confusing,..." Nope. Quite clear.<br /><br />One way (my preferred way) to introduce changes in expected inflation into ISLM is to stick a vertical wedge between the IS and LM curves (to the right/left of where they cross, if expected inflation is positive/negative). The height of the wedge equals the expected inflation rate. Read nominal i off the LM curve (top of the wedge) and real r off the IS curve (bottom of the wedge).<br /><br />"In the monetarist view, the solution to a shortfall in aggregate demand is always more money,..." Remember that both current and expected future money supplies matter. An increase in expected future money (via raising expected inflation) reduces the current demand for money. (Slightly off-topic, but Silvio Gessel's tax on money can be seen as a sort monetarist policy, that also works by reducing the demand for money.)<br /><br />Attacking the substance of your good post (though there is much here I agree with):<br /><br />1. The upward-sloping (as opposed to vertical) LM curve only makes sense under the assumption that "money" pays an exogenously fixed 0% nominal interest. That is true for currency, but is not generally true. The whole model rests on one very institution-specific assumption. Drop that assumption, and interest rates lose their role as affecting the demand for money.<br /><br />2. Let me throw this old post at you:<br />http://worthwhile.typepad.com/worthwhile_canadian_initi/2013/09/interest-rates-and-aggregate-demand.html<br />Nick Rowehttps://www.blogger.com/profile/04982579343160429422noreply@blogger.com