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Inside money, outside money and short-term interest rates

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  • V. V. Chari
  • Lawrence J. Christiano
  • Martin Eichenbaum

Abstract

This paper presents a quantitative general equilibrium model with multiple monetary aggregates. The framework incorporates a banking sector and distinguishes between M1, the monetary base, currency and various measures of reserves: total, excess and non borrowed. We use a variant of the model to analyze two sets of empirical facts. The first set of facts is that different monetary aggregates covary differently with short term nominal interest rates. Broad monetary aggregates like M1 and the monetary base covary positively with current and future values of short term interest rates. In contrast, the non borrowed reserves of banks covary negatively with current and future interest rates. Observations like this `sign switch' lie at the core of recent debates about the effects of monetary policy actions on short term interest rates. According to our model, the sign switch occurs because movements in non borrowed reserves are dominated by exogenous shocks to monetary policy, while movements in the base and M1 are dominated by endogenous responses to non-policy shocks. The second set of facts that we consider is that broad monetary aggregates covary positively with output. We quantify the Friedman and Schwartz hypothesis that this covariation reflects the effects of exogenous shocks to monetary policy, and the hypothesis that they reflect the endogenous response of monetary aggregates to shocks in the private economy.

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Bibliographic Info

Article provided by Federal Reserve Bank of Cleveland in its journal Proceedings.

Volume (Year): (1994)
Issue (Month): ()
Pages: 1354-1401

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Handle: RePEc:fip:fedcpr:y:1994:p:1354-1401

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Keywords: Business cycles ; Monetary policy ; Econometric models ; Interest rates;

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  1. Ben S. Bernanke & Ilian Mihov, 1995. "Measuring monetary policy," Working Papers in Applied Economic Theory, Federal Reserve Bank of San Francisco 95-09, Federal Reserve Bank of San Francisco.
  2. Andreas Hornstein & Edward C. Prescott, 1989. "The firm and the plant in general equilibrium theory," Staff Report, Federal Reserve Bank of Minneapolis 126, Federal Reserve Bank of Minneapolis.
  3. Lawrence J. Christiano & Martin Eichenbaum, 1990. "Current real business cycle theories and aggregate labor market fluctuations," Discussion Paper / Institute for Empirical Macroeconomics, Federal Reserve Bank of Minneapolis 24, Federal Reserve Bank of Minneapolis.
  4. Burnside, A Craig & Eichenbaum, Martin & Rebelo, Sérgio, 1995. "Capital Utilization and Returns to Scale," CEPR Discussion Papers, C.E.P.R. Discussion Papers 1221, C.E.P.R. Discussion Papers.
  5. Lucas, Robert Jr., 1990. "Liquidity and interest rates," Journal of Economic Theory, Elsevier, Elsevier, vol. 50(2), pages 237-264, April.
  6. Christiano, Lawrence J., 1988. "Why does inventory investment fluctuate so much?," Journal of Monetary Economics, Elsevier, Elsevier, vol. 21(2-3), pages 247-280.
  7. Lawrence J. Christiano & Martin Eichenbaum, 1992. "Liquidity Effects and the Monetary Transmission Mechanism," NBER Working Papers 3974, National Bureau of Economic Research, Inc.
  8. Gary Hansen, 2010. "Indivisible Labor and the Business Cycle," Levine's Working Paper Archive 233, David K. Levine.
  9. Hodrick, Robert J & Prescott, Edward C, 1997. "Postwar U.S. Business Cycles: An Empirical Investigation," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 29(1), pages 1-16, February.
  10. Christiano, Lawrence J & Eichenbaum, Martin, 1995. "Liquidity Effects, Monetary Policy, and the Business Cycle," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 27(4), pages 1113-36, November.
  11. Lawrence J. Christiano & Martin Eichenbaum, 1991. "Identification and the Liquidity Effect of a Monetary Policy Shock," NBER Working Papers 3920, National Bureau of Economic Research, Inc.
  12. Kydland, Finn E. & Prescott, Edward C., 1988. "The workweek of capital and its cyclical implications," Journal of Monetary Economics, Elsevier, Elsevier, vol. 21(2-3), pages 343-360.
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