Non-monetary Assets Research Articles

Currency substitution, capital mobility and money demand

This paper re-examines the currency substitution (CS) issue by specifying a general portfolio balance (PB) model where domestic residents' demand for foreign money is distinguished from their demands for foreign non-monetary assets. The latter possibility, which reflects international capital mobility as opposed to CS per se, is already a key feature in the open-economy macro literature. The inclusion of foreign money leaves the usual asset demand functions unchanged (in the PB model that ignores CS), at least as far as the appropriate rate-of-return arguments and their signs are concerned. Although this suggests that CS is of limited importance in macro modelling, it implication for the estimation of money demand functions is pursued. An initial attempt is made to empirically isolate the separate efects of high capital mobility and currency substitution for Canada, Germany, the United Kingdom, and the United States. The results, while not conclusive due to high multicollinearity problems, bring into question the empirical as well as the theoretical relevance of currency substitution.

Some implications of the natural rate hypotheses

Changes in the anticipated and actual levels of inflation change the incentive to hold monetary and nonmonetary assets. We present a model with a production sector and markets for labor, capital, bonds, and money. The response of the model to changes in the anticipated inflation rate is derived. Restrictions implied by the various natural rate hypotheses are discussed. An asymmetry in the response of the economy to anticipated inflation and deflation makes the natural rate conditions more plausible for inflationary as opposed to deflationary equilibria. A new version of the liquidity trap is suggested by the analysis.

Discussion: The Exposure of Long-Term Foreign Currency Bonds

The unique characteristic of a foreign asset is that the real purchasing power of the cash flows from the asset depends on the exchange rate prevailing on the conversion date. A naive view is that this dependence exposes foreign assets to exchange risk proportional to the volatility of the exchange rate and, other things equal, makes foreign assets much riskier than domestic ones. Anothe extreme is that for nonmonetary foreign assets, purchasing power parity (PPP) causes exchange rates to move inversely todifferential inflation rates, thereby eliminating exchange risk. Aliber and others maintain that a similar argument applies to foreign monetary assets. The international Fisher effect (IFE) causes the exante equilibrium return on all default-free monetary assets, measured in the domestic currency, to be the same regardless of the currency denomination of the instrument. The fact is, however, that PPP and IFE cannot be expected to hold instantaneously throughout time, but only on average over time. Consequently, although foreign assets may promise the same expected return as domestic assets, they will have a higher variance of return as seen by domestic investors. To justify the holding of foreign assets by a domestic investor, one must introduce portfolio considerations, the possibility of consumption expenditures denominated in the foreign currency, heterogeneous expectations, or market imperfections.

On Affluence and Economic Conflict

EXCHANGE IS A PECULIAR FORM of agreement in that the interests of the parties involved are partly in conflict.' Since ours is an exchange economy, the subject arises as to whether the scale of economic conflict should theoretically become less intense as the supply of goods produced by the economy's resources increases. The question considered here is whether high and growing per capita consumption would tend to lessen economic conflict among people for the economy's output of goods and services. In theory at least, conflict can be measured by the intensity with which the individual applies himself to the bargaining aspect of the exchange agreement and by the time input involved in bargaining. Exchange agreements may be defined as contracts negotiated in order to exchange labor services, non-monetary assets, or monetary assets among persons. It is the existence of mutual gains from trade which induces individuals to make contracts with one another, and each individual endeavors to drive a shrewd bargain in order that he may increase his total utility both absolutely and relatively to that of his fellows. Thus aggregate economic conflict among persons in society would seem to be a function of the number of agreements struck and the amount of bargaining which entered each of those agreements. In order to consider whether growing per capita consumption tends to reduce conflict, it is necessary to analyze the effect of affluence on each of these indicators of conflict.

A Note on the Liquidity and Stabilization Effects of Savings Deposits

Money, conventionally defined as demand deposits and currency held by the nonbank public, has two principal functions. It serves as a medium of exchange and as an asset conferring perfect liquidity on the holder. Savings deposits in commercial banks, savings and loan associations, mutual savings banks, credit unions, and the postal savings system are almost like money. For all practical purposes, they are perfectly liquid assets, or at least considered as such by depositors, and therefore substitutable for asset money. Because interest is paid on savings deposits, and not on demand deposits (except for an implicit return received through checking services provided below cost), it can be reasonably argued that the long-term asset demand for money (money that people expect to hold over six months) is considerably less than it would be in the absence of savings deposits. This does not mean, however, that the sum of currency, demand deposits, and savings deposits measures what the demand for money would be if savings deposits did not exist. Some savings deposits are certainly held in lieu of nonmonetary assets.

Price Variation Accounting-A Rejoinder

The differences between Professor Chambers and myself undoubtedly result, as he points out in his most recent contribution to the debate,' from differences in the definition and measurement of income. The particular point at issue is the extent to which changes in the general purchasing power of money should be reflected in the income of an individual firm. In my earlier paper,2 I argued that the full distribution of income as defined and measured in Chambers' system would have the effect of maintaining residual equity in terms of general purchasing power, but that, to the extent that the specific price increase in respect of nonmonetary assets (Nr) exceeds the change in general purchasing power of the residual equity (Rp), the residual equity at the end of the period no longer commands the same quantity of operating assets N at their new prices N(1 + r). Chambers endeavored to refute this proposition by means of the following arithmetical example: