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Money demand and macroeconomic stability revisited

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  • Schabert, Andreas
  • Stoltenberg, Christian

Abstract

This paper examines how money demand induced real balance effects contribute to the determination of the price level, as suggested by Patinkin (1949,1965), and if they affect conditions for local equilibrium uniqueness and stability. There exists a unique price level sequence that is consistent with an equilibrium under interest rate policy, only if beginning-of-period money enters the utility function. Real money can then serve as a state variable, implying that interest rate setting must be passive for unique, stable, and non oscillatory equilibrium sequences. When end-ofperiod money provides utility, an equilibrium is consistent with infinitely many price level sequences, and equilibrium uniqueness requires an active interest rate setting. The stability results are, in general, independent of the magnitude of real balance effects, and apply also when prices are sticky. In contrast, under a constant money growth policy, equilibrium sequences are (likely to be) locally stable and unique for all model variants. JEL Classification: E32, E41, E52

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Paper provided by European Central Bank in its series Working Paper Series with number 0458.

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Date of creation: Mar 2005
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Handle: RePEc:ecb:ecbwps:20050458

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Keywords: monetary policy rules; predetermined money; price level determination; Real balance effects; real determinacy;

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Citations

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Cited by:
  1. Bruckner, Matthias & Schabert, Andreas, 2006. "Can money matter for interest rate policy?," Journal of Economic Dynamics and Control, Elsevier, vol. 30(12), pages 2823-2857, December.
  2. Stephen McKnight & Alexander Mihailov, 2012. "Do real balance effects invalidate the Taylor principle in closed and open economies?," Serie documentos de trabajo del Centro de Estudios Económicos 2012-10, El Colegio de México, Centro de Estudios Económicos.
  3. Christian Stoltenberg, 2006. "Real Balance Effects, Timing and Equilibrium Determination," SFB 649 Discussion Papers SFB649DP2006-073, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.

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