Monetary Theory Research Articles

Merchants of Debt at the Extreme Overnight: Re-Considering Monetary Theories via Rollover-Induced Interbank Frictions

ABSTRACT Banks’ refusal to roll over short-term interbank debts has received increased attention since the global financial crisis. Yet, heterodox monetary theories ignore interbank transactions and rollover channels despite recognising the importance of banks’ debt-renewal practices. Against this backdrop, this research contextualises banks’ refinancing vulnerabilities within heterodox monetary theories and relates them to the literature on rollover-induced interbank frictions. This study also reveals a further shock amplifier. Due to the interplay between maturity-rollover and market-funding liquidity cycles, a rollover-circuit may emerge. This circuit may lead to additional threats to the operation of the interbank market and financial stability, compelling monetary theories not to further neglect banks’ refinancing issues.

Endogenous money supply, global liquidity and financial transactions: Panel evidence from OECD countries

Research background: Endogenous money creation is an inherent feature of today?s economies and widely accepted phenomenon. As the various theories of money rely on the money quantity equation, most empirical research is heading towards the analysis of the two-way relationship between the quantity of money and nominal GDP. In today's world, with the extraordinary development of the financial sector, money is used not only for transactions in the real economy, but increasingly also for purchasing financial assets. This observation was absorbed by Werner in the quantity theory of disaggregated credit. Purpose of the article: The aim of the paper is to join the debate on endogenous character of money supply by tasting a disaggregated equation of money. It assumes that the domestic money supply is positively determined not only by growth in GDP-based transactions but also by growth in non-GDP-based transactions (financial transactions). Additionally, it is assumed that in the age of globalization it can be also positively influenced by the global liquidity. Methods: Testing of the above-mentioned hypotheses takes place with the use of panel unit roots tests, panel Granger causality test and panel estimations (OLS, models with fixed/random effects, GMM). In the study, annual data from 2002 to 2018 for OECD countries were chosen for statistical research. Findings & value added: The article confirms the hypothesis that real and financial economic activity together with global liquidity positively influence domestic credit and thus money supply. As the amount of money in an economy is driven not only by the real economy but also by the financial economy, prudential regulations that restrict leverage (and thus control the amount of credit) and limit risk-taking during price bubbles periods should be therefore considered. In the research, the reaction of domestic money supply to the changes in US money supply is positive. It confirms the importance of spill-over effect of expansionary policy in major economies to other economies.

Становлення мікро- та макроекономічного аналізу фінансового посередництва. Стаття перша. Теорії посередницьких функцій банків Д. Даймонда і Ф. Дибвіга та становлення мікроекономічного аналізу фінансових інституцій

The first of two articles which reveal the theoretical and practical significance of the researches awarded 2022 Sveriges Riksbank Prize in Economic Sciences. The author shows that the laureates laid the foundations of both the modern microeconomic theory of banks and financial institutions and the analysis of the role of financial intermediation in macroeconomic cycles. It is found that until the 1980s two powerful theoretical traditions dominated in the analysis of financial intermediation. The first tradition was to consider banks primarily as subjects of the money supply. It originates from the controversy between the quantitative theory of money and the real bills doctrine and culminates in the outstanding work by M. Friedman and A. Schwartz. The second tradition was a well-formalized neoclassical approach to the financial system. It was based on the efficient markets hypothesis, the Modigliani-Miller theorem, and the banking theory of E. Fama, where financial institutions are only a veil for real economic activities. It is shown that the growth of interest in the micro- and macroeconomic aspects of the financial sector activities in the late 1970s was due to the growth of its power due to the development of technologies and globalization, and due to the emergence of information economic theory which created a theoretical basis for the endogenous derivation of financial intermediaries that overcome market imperfections in ensuring the flow of funds between savers and borrowers. The article reveals the theoretical and practical importance of D. Diamond and Ph. Dybvig’s works, in which a bank endogenously arises as an optimal contract for solving important socio-economic problems of financing long-term projects with liquid deposits and of delegated monitoring of borrowers. The author emphasizes the importance of the scientists’ analysis and formalization of the incentives that determine the peculiarities of the intermediary role of banks and the nature of their services for financial regulation. It is shown that the model of delegated monitoring by D. Diamond not only demonstrates social benefits of specialization in monitoring, but also solves the problem of depositors' monitoring a bank as a monitor, revealing the incentives for the efficient implementation of borrowers monitoring by the bank: in conditions of diversification of borrowers, when their profits have an independent probability distribution, monitoring helps to avoid liquidation even in the event that part of the borrowers' projects are not successful. It is concluded that the formalization of the banks’ built-in vulnerability in the Diamond-Dybvig model, associated with their function of maturity transformation, and its overcoming by government institutional mechanisms, which, among other things, can distort the banks’ incentives, in effect substantiate the "symbiosis" of a state and banks in ensuring the latter’s stable functioning.

The primacy of the European Central Bank: Distributional conflicts between theory and practice in the pursuit of price stability

Whether fighting inflation or deflation, it has been a decade since the European Central Bank (ECB) managed to successfully attain its Treaty-mandated objective, that is, price stability. This is defined by the Bank itself as maintaining an inflation target of ‘below but close to 2% over the medium term’ and, since 2021, as ‘2% over the medium term’. The further reality has veered from policy, the more attention has been brought to the redistributive choices, both implicit and explicit, in the ECB’s pursuit of price stability. The current article analyses this debate in the context of the legal terms stipulated in the Treaty on the Functioning of the European Union, conceptualised as a function of monetarist theory. It claims that the ECB’s failure to deliver on its price stability objective has contributed to intensifying the re-politicisation of monetary policy, cast doubt on the presumed legitimacy of foundational monetarist theory and caused a legal struggle within EU constitutionalism to sustain a stable distinction between economic and monetary policy.

Monetary economy and budget deficit in endogenous growth model

AbstractBy an endogenous growth model with two‐period overlapping generations structure and money holding of consumers, we examine the existence of budget deficit in an economy which endogenously grows by investments of firms. The main results are as follows. (1) Budget deficit is necessary for full employment under constant prices. (2) Inflation is induced if the actual budget deficit is greater than the value at which full employment is achieved under constant prices. (3) If the actual budget deficit is smaller than the value which is necessary and sufficient for full employment under constant prices, a recession occurs. Therefore, balanced budget cannot achieve full employment under constant prices. We do not assume that budget deficit must later be made up by budget surplus. This paper is an example of an analysis using a very simple model of the following statement by John Maynard Keynes.“Unemployment develops, that is to say, because people want the moon;—men cannot be employed when the object of desire (i.e. money) is something which cannot be produced and the demand for which cannot be readily choked off. There is no remedy but to persuade the public that green cheese is practically the same thing and to have a green cheese factory (i.e. a central bank) under public control.”In the appendix of this paper, we show that if money as well as goods are produced by capital and labor, budget deficit is not necessary for full employment under constant prices.

Analysis of the Factors Affecting the Price Fluctuation of Bitcoin

According to the monetary theory, this paper believes that the demand for Bitcoin mainly includes two aspects: transaction demand and investment demand. This paper further discusses the impact of different demands on the price of Bitcoin based on two aspects of demand. Transaction demand and investment demand together affect the supply and demand relationship of the Bitcoin market. The empirical results show that the volatility of Bitcoin price is higher than that of international currencies and stocks as investment tools. This article emphasizes that the price of Bitcoin is primarily affected by supply and demand.

The Money War: democracy, taxes and inflation in the U.S. Civil War

Abstract Both sides in the U.S. Civil War financed military spending by issuing new fiat currencies. The Union ‘greenback’ underwent moderate inflation (by wartime standards), but the Confederate ‘greyback’ suffered hyperinflation. Existing explanations for these price movements typically treat only one of the two cases and adopt either a quantity theory or rational expectations approach. We compare Union and Confederate policies directly and highlight the importance of taxation for assuring the value of inconvertible money. Combining monetary and fiscal history literatures, we find that tax policies were determined by long-term development of democratic governing institutions. Higher levels of democracy in the North, as compared to the slaveholding South, meant greater tax policy legitimacy and administrative competence. The Union drew on this legacy to back its money effectively, while the Confederacy failed to do so. We contribute to credit theories of money by drawing attention to the political determinants of effective fiscal policy.

Secured Loans and Risky Assets in a Monetary Economy

AbstractWe study the implication of secured credit with a default option for monetary equilibrium. The intermediary structure has the feature of costly state verification, with the monitoring cost interpreted as the cost of foreclosing assets once a default occurs. Without monitoring costs, uncertainty in asset payoffs does not matter for allocation. The asset price can exhibit a liquidity premium because more assets as collateral raises the borrower's credit limit. When there are monitoring costs, the asset's liquidity premium is strictly positive because pledging more assets reduces the default probability and thus the chance to incur monitoring costs. Under some circumstances, increased risk to dividends of the pledged asset may decrease the marginal borrowing cost to such an extent that bank lending rises, and higher default rates are accompanied by larger aggregate liquidity.

Corruption in Bangladesh: Background Causes and Current Scenario

While Bangladesh is characterized by impressive rates of economic growth and significant improvement in several development indicators, it is also marked by high levels of corruption. This study engages with bribery to show that it has become a norm in transactions, which has made it a systemic part of the Bangladeshi economy. It argues that the state-sanctioned involvement of untrained individuals such as ruling party members and freedom fighters in running the state machinery is a significant factor for the genesis and consolidation of corruption in Bangladesh from 1972 to 2013. The introduction of such candidates into the civil service, public sector enterprises has led to the expropriation by a few leading to the development of crony capitalism in the country. Furthermore, it posits Bangladesh as a key site for the illustration of speed money theory.

Perceived FOMC: The making of hawks, doves and swingers

An important and open question in monetary economics is how the Federal Reserve makes its policy decisions. We document that when an FOMC member was born, his/her educational background and the Committee’s changing hawk-dove composition have predictable effects on FOMC decisions. The odds of an FOMC member being a hawk are higher when he/she graduated from a university linked to the Chicago school of economics; instead, a dove likely graduated from a university with strong Keynesian beliefs and was born during a period of high unemployment. These findings have implications for the choice of and confirmation of FOMC members.

The New Economics: A Manifesto

Steve Keen has written an important book that should spark the interest of economists and others interested in pressing economic problems. It contains six chapters. The introductory chapter is entitled ‘Why this manifesto?’ It argues that economics is in a bad state and that a Kuhnian paradigm shift is required to overcome the limitations of the neoclassical approach. Although the necessary changes have been long resisted, such a paradigm change is now deemed possible because of (i) ‘the development of … computer software that can easily handle large-scale dynamic and even evolutionary processes’ (p. 14), (ii) the development of post-Keynesian, and other non-neoclassical theory in recent decades, particularly the ‘modern monetary theory’ of Warren Mosler, Randall Wray, Stephanie Kelton, and others, and (iii) the upsurge of protest by economics students and others against the alleged failure of their teachers to explain the Great Crash of 2008 or to take it seriously as a problem for mainstream economics.

Financialisation: Economic and Social Impacts

Malcolm Sawyer is a distinguished figure in heterodox macroeconomics, specialising in financial economics and monetary economics. From 2011 to 2016, he was the principal investigator of a major international research project on Financialisation, Economy, Society, and Sustainable Development, which was funded by the European Union. This was a collaboration between 14 major universities: ‘A multi-disciplinary, pluralistic project which aims to forge alliances across the social sciences, so as to understand how finance can better serve economic, social and environmental needs’. His book, Financialisation: Economic and Social Impacts, which draws heavily on this research, ‘documents the growing scale and importance of financial institutions and markets, how the financial sector has evolved and changed since the 1970s, and which forces have generated that growth’ (p. 3). There are many definitions of financialisation to choose from, and he adopts that of Epstein (2005): ‘financialization means the increasing role of financial motives, financial markets, financial actors, and financial institutions in the operation of the domestic and international economies’.

Two theories of money

Abstract The last decade of financial crisis, “financialization” and “quantitative easing” has been a feast of public learning about money and finance. Anthropology, history, and political economy rediscovered a “forgotten” history of money as fundamentally a public good rather than basically a private one. This article discusses the rediscovery of the two competing basic historical theories of money. It also notes that, after a turbulent decade of class and political polarization, including a worldwide pandemic, we also learned that under capitalism it just cannot be publicly conceded that money, if we want to, costs nothing, even though that is scientifically true. The article then reflects upon the current return of inflation and the turn toward “hard and dear money,” and what that might mean.

The Effect of Financial Inclusion and Financial Literacy on Financial Integration of West African Monetary Zone (Wamz)

Deepening financial integration is important for developing economies especially in Africa, that accounts for less than 2% of the world's market capitalization. Financial integration facilitates risk sharing, aids the formation of larger markets which is beneficial to the firms and smoothens consumption inter-temporally. Financial integration will be enhanced through a well-developed financial sector that is all-inclusive of the economic agents in access to financial services at a low cost and at the most convenient time. The access to funds in an integrated market is further determined by the extent of financial knowledge acquired by the economic agents with respect to basic numeracy, interest compounding, understanding inflation and risk diversification. This paper examines the effect of increasing access to financial services and the level of knowledge of financial products on the financial integration of West African Monetary Zone. The ratio of total capital flows to GDP and interest rates on public debt were used in measuring financial integration while the measures of financial inclusion include the number of commercial bank branches, number of ATM machines available, Savings, number of account holders and credit to private sector. Data covering the period 1980–2020 were employed. Unit root test using Levin, Lin and chu t-test method and Im, et al statistics methods were employed while the cointegration test was conducted using the Wald t-test before the panel autoregressive distributed lag model estimation technique was used to estimate the models. The unit root test results revealed that three out of the ten variables were stationary at level whiles others were stationary at first difference. The Wald cointegration test shows that the two equations are cointegrated. The results from the study show that increasing the number of bank branches; the number of account holders; savings; credit to private sector and improvement in the level of financial knowledge with respect to financial services deepen financial integration of the West African Monetary Zone. The policy implication of the paper is that each economy's monetary authority and financial service providers must continue to advocate and institutionalise programmes that will deepen access to and knowledge of financial services, this will improve the extent of financial integration.

Austrian Monetary Theory: Comment on Pascal Salin’s Paper

The paper in this issue by Professor Salin comparing the Austrian and Chicago schools in the field of monetary theory is very stimulating. One would expect nothing less from a leading monetary theorist sympathetic to both schools. Austrians can learn a lot from engaging with non-Austrian approaches to monetary theory and economics generally. After all, one can learn from the refutation of false doctrines as well as from true theories expounded outside one’s own school of thought. In the case of the Chicago school, there is the opportunity to do both: although there are many similarities between Chicago and Austrian monetary theory, the differences are crucial and, as is argued in this reply, generally suggest the superiority of the Austrian position.

The Monetary Economics of the Austrian School and the Chicago School

To what extent is there complementarity or agreement between Austrian economics and the Chicago school on monetary issues? Both Austrians and Chicagoans would agree that monetary expansion has real effects in the short run, though they emphasize different variables. In the long run, Austrians argue that there is a lasting real effect of monetary expansion—money is not neutral—but Chicagoans too argue that economic activity is less efficient even if people correctly forecast the rate of inflation. Regarding the balance of payments, both the Austrian and Chicago school lead to the conclusion that there can be no balance-of-payments problem. Both are modern versions of the classical price specie flow theory. Perhaps the Austrian approach to monetary economics and the Chicago school approach are more compatible than is commonly thought.

Comment on Salin’s “The Monetary Economics of the Austrian School and the Chicago School”

Well-intended and richly argued as Salin’s proposal for reconciliation between the Austrian School and Chicago School is, it eschews a discussion of one aspect of the two schools that is also relevant to their respective monetary views; namely, their analytical method. This short comment aims to clarify why the specific praxeological approach of the Austrian school makes its monetary theory unique. By implication, as long as methodological differences between the Austrian and the Chicago traditions persist, no reconciliation will be within reach. This comment concludes that this is the decisive, though unintended, contribution of Salin’s article.

Testing the Validity of the Quantity Theory of Money on Sectoral Data: Non-Linear Evidence from South Africa

Purpose: The purpose of this study is to test the validity of the quantity theory of money (QTM) on South African sectoral data. The rationale of this study and its necessity for South Africa as the case study is that, although aggregate inflation may lie within the target range, inflation at a sectoral level, particularly in the food and transport sector, is still a matter of concern in South Africa. Methodology/approach: This study employed the Non-linear Autoregressive Distributed Lagged model (NARDL) to assess potential asymmetries in the effect of money supply to differentiate between the effects of contractional and expansional episodes on inflation at the sectoral level. Quarterly time series data spanning from 2002Q2 to 2021Q2 was utilised for the estimation. Ultimately, the causal effect amongst the variables is examined by employing the Pairwise Granger Causality test. Findings: The results suggest that in the short run, the effect of monetary policy shocks is very weak. On the other hand, in the long run, both negative and positive shocks in the money supply push inflation at the sectoral level in the opposite directions, and positive shocks (expansionary monetary policy) have a greater effect than negative shocks, which renders the QTM invalid in South Africa. The sectoral response was found to be heterogeneous in the long run, and this was also backed by the results of the Granger Causality test and the dynamic multipliers. Asymmetry in the effect of the money supply is assessed in some of the sectors only in the long run. Practical implications: Based on the results, this study confirms great discrepancies in sectoral responses. Therefore, aggregate inflation may not be a good indicator of the inflation path in South Africa, as it may underestimate sectoral variations. Originality/value: The originality of this study lies on testing the validity of the QTM on inflation at the sectoral level in the South African context using a non-linear approach to assess potential asymmetry between the effects of expansionary and contractionary episodes of monetary policy shocks.

Schumpeter’s insights for monetary macroeconomics and the theory of financial crises

Abstract The purpose of this paper is to show that Schumpeter can offer important insights for macroeconomic theory today. This applies especially to his distinction between a “real analysis” and a “monetary analysis,” as he calls it, and its implications for monetary macroeconomics, especially the theories of financial crises at the national and the global levels. The main problem of the “real analysis” is the identity of the financial sphere with the real sphere. The consequence of this narrow view is the inability to understand the dynamics of a monetary economy, which is the main cause for financial crises. The flaws of the real analysis manifest themselves also at the global level. The Feldstein–Horioka puzzle and the Lucas paradox are obvious “anomalies” of this paradigm. Models based on the real analysis are unable to explain the extent and even direction of international capital flows. Thus, the economics profession was unable to see the risks that were accumulating in the international financial system before the outbreak of the Great Financial Crisis.

ISSUES OF IMPROVING THE SYSTEM OF INTERACTION OF ENTERPRISES WITH COMMERCIAL BANKS

This article will consider the concept of improving the system of relations between enterprises and commercial banks. Banks are an integral part of the modern monetary economy as a whole, and their activities are closely related to the need to develop and increase the use of an effective mechanism for lending to enterprises used to meet the needs of enterprises and banks.