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Shrinking money and monetary business cycles

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Author Info

  • Harold L. Cole
  • Lee E. Ohanian

Abstract

In the postwar period velocity has risen so sharply in the U.S. that the ratio of money to nominal output has fallen by a factor of three. We analyze the implications of shrinking money for the real effects of a monetary shock in two classes of equilibrium monetary business cycle models: limited participation (liquidity) models and predetermined (sticky) price models. We show that the liquidity model predicts that a rise in velocity leads to a substantial reduction in the real effects of a monetary shock. In sharp contrast, we show that the real effects of a monetary shock in the sticky price model are largely invariant to changes in velocity. We provide evidence that suggests that the real effects of monetary shocks have fallen over the postwar period.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Minneapolis in its series Working Papers with number 579.

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Date of creation: 1997
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Handle: RePEc:fip:fedmwp:579

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Related research

Keywords: Business cycles;

References

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  1. Ireland, Peter N, 1994. "Money and Growth: An Alternative Approach," American Economic Review, American Economic Association, vol. 84(1), pages 47-65, March.
  2. Pagan, A.R. & Robertson, J.C., 1994. "Resolving the Liquidity Effect," Papers 277, Australian National University - Department of Economics.
  3. Robert E. Lucas, Jr. & Michael Woodford, 1993. "Real Effects of Monetary Shocks in an Economy with Sequential Purchases," NBER Working Papers 4250, National Bureau of Economic Research, Inc.
  4. Robert J. Barro, 1979. "A Capital Market In an Equilibrium Business Cycle Model," NBER Working Papers 0326, National Bureau of Economic Research, Inc.
  5. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 1994. "The Effects of Monetary Policy Shocks: Some Evidence from the Flow of Funds," NBER Working Papers 4699, National Bureau of Economic Research, Inc.
  6. Schlagenhauf, Don E. & Wrase, Jeffrey M., 1995. "Liquidity and real activity in a simple open economy model," Journal of Monetary Economics, Elsevier, vol. 35(3), pages 431-461, June.
  7. Bental, Benjamin & Eden, Bemjamin, 1996. "Money and inventories in an economy with uncertain and sequential trade," Journal of Monetary Economics, Elsevier, vol. 37(3), pages 445-459, June.
  8. Ohanian, Lee E & Stockman, Alan C & Kilian, Lutz, 1995. "The Effects of Real and Monetary Shocks in a Business Cycle Model with Some Sticky Prices," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(4), pages 1209-34, November.
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  18. Eden, Benjamin, 1994. "The Adjustment of Prices to Monetary Shocks When Trade Is Uncertain and Sequential," Journal of Political Economy, University of Chicago Press, vol. 102(3), pages 493-509, June.
  19. King, Robert G., 1988. "Money demand in the United States: A quantitative review," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 29(1), pages 169-172, January.
  20. Barnett, William A & Offenbacher, Edward K & Spindt, Paul A, 1984. "The New Divisia Monetary Aggregates," Journal of Political Economy, University of Chicago Press, vol. 92(6), pages 1049-85, December.
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  23. Mankiw, N Gregory, 1985. "Small Menu Costs and Large Business Cycles: A Macroeconomic Model," The Quarterly Journal of Economics, MIT Press, vol. 100(2), pages 529-38, May.
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Cited by:
  1. Cooley, Thomas F. & Hansen, Gary D., 1998. "The role of monetary shocks in equilibrium business cycle theory: Three examples," European Economic Review, Elsevier, vol. 42(3-5), pages 605-617, May.
  2. Hromcova, Jana, 1998. "A note on income velocity of money in a cash-in-advance economy with capital," Economics Letters, Elsevier, vol. 60(1), pages 91-96, July.

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