Working Paper

Inside money and monetary neutrality

Abstract: This paper examines the interaction between the financial and real sectors of the economy within the framework of a stochastic, rational expectation model that distinguishes between inside and outside money. The model also can be used to study the impact of variations in the degree of intermediation, measured by the elasticity of bank deposit supply. In contrast to earlier work which emphasized confusion between monetary and real shocks, we focus on the role played by confusion between inside and outside money and temporary and permanent base money disturbances. Financial sector disturbances, as well as temporary shocks to the monetary base, are shown to have real effects even when private agents have complete information. When contemporaneous information on economic disturbances is incomplete, permanent shocks to the monetary base also have real effects. If our model is correct, it is invalid to reject equilibrium models of the business cycle on the grounds that anticipated money affects output. We argue that this result is robust in the sense that many \"reasonable\" models which incorporate inside money would yield a non-neutrality of portfolio and temporary base money supply shocks.

Keywords: Monetary theory;

Bibliographic Information

Provider: Federal Reserve Bank of San Francisco

Part of Series: Working Papers in Applied Economic Theory

Publication Date: 1986

Number: 86-01