Exogenous Money Research Articles

Exogeneity of Money and its Policy Implications for Price Control: Evidence from South Asia

Abstract. We investigate the policy role that could be assigned to money stock in controlling the price level in four South Asian countries, namely, India, Nepal, Pakistan and Sri Lanka. The problem of policy assignment associated with the Granger non‐causality tests is pointed out. Various forms of exogeneity are tested. Money stocks (M1 and M2), consumer price index (CPI) and real GDP are cointegrated and causally related but we find overwhelming evidence of endogeneity of money. The endogeneity of money does not support the authorities’ policy stance of controlling price level through the control of money stock.

The Barings Crisis in Argentina: The role of exogenous European money market factors

The Barings crisis of 1890 was a wrenching financial crash and recession for Argentina. The episode is similar in many respects to the balance of payments difficulties in emerging markets during the 1990s. In particular, it serves as an example of the dangers of investment that is exogenous to the capital-importing, developing country, as opposed to investment driven by country-specific conditions. While some external factors, such as competition among European merchant banks, have been examined for their role in pushing capital into the South American nation, no paper has yet examined the specific conditions in European money markets as the boom began. This paper fills that gap. An examination of financial variables reveals that returns were low and financial investment opportunities few in England, which motivated capital to leave the country. This situation resembles the early 1990s, when interest rates were low in the USA and Japan, and capital went to emerging markets in search of higher compensation. Likewise, British interest rates and other indicators were low in the 1880s, providing motives for capital to go abroad. These incentives were sufficiently strong that warning signs from Argentina were ignored, thus leading to the crash.

The long and short of money and prices: a market equilibrium approach

The paper examines the exogeneity of money and prices within a money demand function. Two modifications to traditional money demand vector error correction modeling are made. The first modification is to introduce a money supply function, while the second is to estimate the behavior of the money sector and real sector simultaneously. Incorporating the additional information removes many of the possible biases and, therefore, allows for more efficient estimation of money and price behavior. Overall, significantly more support is found for the existence of ‘buffer stock’ relationships than has been found in the previous research.

On exogenous money and bank behaviour: the Pandora's box kept shut in Keynes' theory of liquidity preference?

This essay examines Keynes' views on banking behaviour and the relationships between central banks and banks as they evolved from his Tract on Monetary Reform to The General Theory. The objective is to clarify in what sense money may be exogenous in his final work. We identify a distinctly Keynesian position on the money-supply process, featuring money exogeneity due to bank behaviour. Our findings run counter to both neoclassical synthesis view on exogenous money cum passive banks as well as the post Keynesian challenge of endogenous money cum passive banks.

The Yugoslav Hyperinflation of 1992–1994: Causes, Dynamics, and Money Supply Process

The paper demonstrates that the Yugoslav hyperinflation, the second highest and the second longest episode in economic history, was driven by excessive money supply that monetized various deficits that emerged upon the disintegration of the country. The identified cointegrating relations showed that money growth was weakly exogenous and affected inflation via currency depreciation. This indicates the presence of exchange-rate-based pricing, whereas the exogeneity of money implies that money was the common stochastic trend fueling currency depreciation and inflation. Money growth itself followed a random walk with a drift, which, together with its exogeneity, was a result of the Central Bank's loss of control over the money supply process.J. Comp. Econom., June 1999, 27(2), pp. 335–353. The University of Belgrade and CES MECON, Kamenička 6, 11000 Belgrade, Federal Republic of Yugoslavia; International Monetary Fund, Fiscal Affairs IS-3574, 700 19th Street NW, Washington, DC 20431; and the University of Belgrade and CES MECON, Kamenička 6, 11000 Belgrade, Federal Republic of Yugoslavia.

The Origins of Money and the Development of the Modern Financial System

The origins of money and banking are explained in nearly every introduction money and banking course, but Wray proposes an alternative approach that emerges from a comparative analysis of economic institutions. Orthodox theory suggests that barter replaced self-sufficiency and increased efficiency by fostering specialization--subsequently, establishing some object as a medium of exchange permits greater efficiency. In essence, the orthodox economist espouses the view that we operate in a free market economy in which neutral money is used primarily to facilitate exchange of real goods, undertaken by self-interested maximizers for personal gain. Institutionalists reject this argument because it emerges from the perspective of a rational economic agent facing scarce resources and unlimited wants--thus, the focus is on choice. Wray states that economic analyses must incorporate interactions between humans and nature, and that the economy is a component of the material life process of society. Hence, the conventionalists' focus on choice should instead be directed at production and distribution. The Wray thesis suggests that money is necessarily endogenously determined: Monetary economies have not, and cannot, operate with exogenous money supply can function with a commodity reserve system, such a system is subject to periodic debt deflations. In sum, the monetarist policy prescription would be counterproductive to systemic stability and would not yield greater control of the money supply.

Monetary policy under flexible exchange rates: When is expansion contractionary?

This paper studies whether the observed instability in the effects of monetary policy could be due to the way in which the behavior functions have been specified in an open economy context. Accordingly, special emphasis is on the specification of the behavior functions to correspond to their foundations in closedeconomy macrotheory. The demand for real money balances, in terms of the expenditure basket of goods, is specified as a function of income in terms of the same basket. Imports are specified as a function of expenditures, being functionally part of expenditures. The supply of labor is specified as a function of the expenditure price. It is shown that the exchange rate overshoots but output declines, to eventually rise above its original level in response to monetary expansion in the real wage model. In the money wage model, output and the exchange rate overshoot their steady-state levels if the expansion eventually leads to an increase in nominal wealth. If it leads to a decrease, both variables undershoot. However, if interest payments on foreign securities are not small relative to the trade balance, many of the effects are reversed. Thus the overshooting result is far from robust even in a standard model with an exogenous money supply.

Financial Constraints, Aggregate Supply, and the Monetary Transmission Mechanism

We derive two propositions identifying the conditions for monetary policy effectiveness due to the interaction of real and financial markets. The first proposition shows that, in a regime of endogenous money, monetary policy is effective even if policy moves are anticipated because changes in the interest rate impinge upon long‐run output.The second proposition shows that in a regime of exogenous money—in which central banks control base money and structural parameters affecting the behaviour of banks—monetary policy affects output if its impact on money is different from its impact on credit.

Toward a Feminist Expansion of Macroeconomics: Money Matters1

Orthodox economics has long been confident that money is of minor importance in life. From Adam Smith onward, we have heard that it is real goods, not money, that determine well-being and that economic scarcity refers to scarce goods and scarce real resources. Though values are expressed in money terms, and money facilitates the circulation of goods, many economists continue to believe that it is both nominal and neutral in exchange relationships. In standard microeconomics, now dominated by the barter models of Walrasian general equilibrium, money plays no role whatever [Minsky 1990]. It is simply a mathematical convenience for avoiding the price permutations of barter. In standard macroeconomics, now dominated by monetarism, the situation is largely similar. Monetarists assert either that money does not matter or that it is all that matters. This reflects the Walrasian foundations of current monetarism: under normal circumstances, money is irrelevant [Minsky 1990]; but, in the closed and timeless Walrasian hermeneutic, nothing ever happens except when the essentially alien force of money is interjected. Orthodox Keynesianism, now in retreat, does include exogenous money as an variable, but it neglects Keynes's [1936] preeminent concern with monetary factors in business cycles.

A stable US money demand function, 1874–1975

We apply recent econometric techniques to the demand for money in the United States over a period of some hundred years, using data previously analyzed by Friedman and Schwartz (1982). Our results parallel those of Hendry and Ericsson's (1991) UK study. We find evidence of a unique long-run money demand function and of a stable short-run demand function which passes a range of diagnostic tests and exhibits parameter constancy. Also, parameter non-constancy in an inverted equation where prices appear as the dependent variable is inconsistent with the hypothesis of exogenous money determining prices through the money demand function.

Currency substitution and exchange rate dynamics: A note

In an interesting paper Girton and Roper [ 1981 ] examine the effects of currency substitution on exchange rate variability. They find that currency substitution increases exchange rate volatility and that the exchange rate is indeterminate when currency substitution approaches infinity. It is only by endogenizing the behavior of money issuers in the second part of Girton and Roper' s paper and by assuming that central banks behave as profit maximizers that they are able to show that currency substitution enhances exchange rate stability. The main reason for the latter result is that central banks are assumed to respond to demand shifts for their currencies in an attempt to maximize profits. The first part of the Girton and Roper paper, dealing with exogenous money supplies, relies heavily on two assumptions. Namely, the assumption that purchasing power parity (PPP) holds at every instant in time and the assumption of perfectly flexible commodity prices. Thus changes in relative money supplies affect relative national price levels immediately, and given PPP, cause proportional changes in the exchange rate. By contrast, expected depreciation of one of the two currencies decreases the differential between its anticipated real return and that of the other currency. This in turn causes a decrease in its demand and a symmetrical increase in the demand for the other currency. Moreover, the demand for the first currency further decreases as its anticipated real return falls in relation to the non-monetary asset. In the latter case, the degree of change in the relative national price levels and hence exchange rate change depends on the degree of currency substitution. If the two currencies are close substitutes, the resulting shifts in their de-

Model Uncertainty, Learning, and the Gains from Coordination

This paper considers gains from international economic policy coordination when there is uncertainty concerning the functioning of the world economy, but also learning about the true model on the part of policymakers. The paper reports estimates of plausible alternative versions of a standard two-country model. Activist policy (either coordinated or uncoordinated) may produce large welfare losses in the absence of learning, if policymakers behave in the wrong model; hence, exogenous money targets and freely flexible exchange rates may be best. However, model learning (from observations on macroeconomic variables) causes coordinated policies to dominate activist uncoordinated policies or exogenous money targets. Copyright 1991 by American Economic Association.

Monetization, economic development and the exogeneity of money

Using Granger causality the authors examine the question of the exogeniety of money in India during its period of most rapid monetization (1970–1975). The paper finds that the demand for money function with the narrow stock of money can be estimated but not with the broad stock of money. There is evidence of feedback between M 2 , monetized income and the rate of interest. An explanation along the lines of Patrick's analysis of supply led financial development is advanced to show the influence of M 2 on income and the rate of interest.

Assertion without Empirical Basis: An Econometric Appraisal of Monetary Trends in ... the United Kingdom by Milton Friedman and Anna J. Schwartz

This paper critically re-evaluates some of the fundamental empirical claims about monetary behavior in the United Kingdom made by Milton Friedman and Anna J. Schwartz in their 1982 book Monetary Trends in the United States and the United Kingdom. We focus on six aspects of their analysis: the exogeneity of money; their claims of the constancy and correct specification of their money-demand equation; their interpretation of a dummy variable in that equation as capturing a "shift in liquidity preference" for 1921-55; their treatment of the interdependence of money, income, prices, and interest rates; and their use of phase-average data. They fail to support many of their empirical assertions with valid econometric evidence: in particular, they leave untested many conditions necessary to sustain their inferences. However, those conditions either are in part directly testable from their data or have testable implications: we test many of those hypotheses and reject virtually all of them. We reject basic claims made for their empirical model of money demand, e.g., those of parameter constancy, price homogeneity, and normality of the disturbances. En route, we show that their model of velocity as a constant performs poorly relative to the "will-o'-the-wisp" model of velocity as a random walk. As constructive evidence against their models, we develop a money-demand model superior to either model of velocity, and which has an unexplained residual variance less than one tenth that of their money-demand equation. This paper, however, is not an "anti-monetarist" critique; rather, it is a pro-econometrics tract which highlights the practical dangers of seeking to analyze complex stochastic processes while eschewing modern econometric methods.

La monnaie est-elle à l’origine du chômage ?

The General Theory offers three explanations as regard unemployment : 1. maximised and anticipated profit comes into sight before full employment ; 2. the shifts in employment are deemed linked to the changes in the agents' preference for liquidity, so that the «liquidity trap» when it emerges, is opposed to the fall in interest rate, blocking investment. This hypothesis would not explain joblessness over a long-medium term period ; 3. the marginal yieldings of assets should be in line with money interest rates. However, if the equilibrium rate for the yield of assets in lower than the liquidity premium, for full employment to be reached there must be a decrease in monetary interest rates which supposes exogenous money supply, inconsistent with effective demand and banking activity. Moreover, it is unrealistic. The only feasible explanation lies in abandoning the explanation in terms of aggregate demand deficit in favour of one in terms of a deficit in aggregate supply.

Ein Vierteljahres-Modell des Geld- und Kreditsektors �sterreichs

This study presents an econometric analysis of the monetary sector of the Austrian economy. The main focus of interest lies in the money and credit markets. We specify nine behavioral equations for the money demand sector, for the commercial banks, for the credit market, and for the bonds market, respectively. Great emphasis is put on the analogous specification of theoretically related equations; these are estimated on a quarterly basis. In order to obtain unbiased estimates we use two-stage-least-squares as estimation technique. All behavioral equations are based on a partial adjustment process. We try to avoid the concept of exogenous money supply and a monetary base completely controlled by the monetary authorities; specifications based on these concepts do not stand up against examination by simultaneous estimation methods. Another important feature of the model lies in the explicit inclusion of the main instruments of monetary authorities into the analysis. We try to show possible influences of these instruments on the monetary sector by means of the model's reduced form and by means of simulation experiments. We also report some preliminary results on the transmission process which can be obtained by combination of the monetary model with a model of the real sector of the Austrian economy. In order to evaluate the forecasting properties of the model we calculate ex post and ex ante forecast errors. In general, the results of this test are satisfactory.

J. Laurence Laughlin and the Quantity Theory of Money

In this paper the issues raised in the turn of the century American debate over the quantity theory of money are examined. J. Laurence Laughlin of Chicago, the leading anti-quantity theorist, provoked the controversty with his theoretical and empirical criticism of the quantity theory, while Irvine Fisher emerged as the chief defender of the monetary orothdoxy. Laughlin attacked the quantity theory position that a change in the quantity of money would cause a proportional change in prices. He argued that issues of convertible paper money in any single open economy would raise prices, but would instead lead to losses of hold through the balance of payments. The seperation of neutrality of money proposition into its two components, the neutrality proposition per sa and the exogeneity of money, isu sed to identify the essential features of the two sides of the debate.

The Stability of Keynesian and Monetary Multipliers in the United Kingdom

The time series of consumption is explained as a consequence of expenditure. The quantity theory hypothesis relates the level of consumption in money terms to the nominal quantity of money. This is, of course, a variant of the normal quantity theory where the level of money income is determined by the amount of money. By subtracting investment from the dependent variable, one makes the quantity theory formulation directly comparable to its Keynesian rival. Money exerts its influence on consumption directly or via elements of expenditure such as investment. With a different definition of autonomous expenditure, we get rather different results for United Kingdom data. Specifically, the monetary hypothesis is more successful for our early period up to the First World War, while the inter-war years are a strongly Keynesian period. After the Second World War, neither model has very high explanatory power, while for the overall period, there is a slightly better fit with expenditure. Exogeneity of Money