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The Monetary Transmission Mechanism

  • Jess Benhabib
  • Roger Farmer

In this paper we take as given that market economies are characterized by a set of stylized responses to increases in the stock of money. Innovations to the stock of money lead to increased output and reductions in short-term interest rates in the short run and only in the long run do nominal prices respond. These features of the monetary transmission mechanism have been discussed at least since David Hume. Most authors have attributed the real effects of money in the short run either to mistaken expectations or to non-market clearing or both. In this paper we argue that neither of these channels is needed to explain the facts. We show that a competitive market clearing model in which money enters the production function is fully capable of mimicking the broad features of the data. Our argument relies on an explanation of ‘price stickiness’ that exploits a multiplicity of equilibria in a rational expectations model.

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Paper provided by David K. Levine in its series Levine's Working Paper Archive with number 2055.

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Date of creation: 05 Mar 1998
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Handle: RePEc:cla:levarc:2055
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  1. Roger E.A. Farmer, 1994. "The Econometrics of Indeterminacy: An Applied Study," UCLA Economics Working Papers 720, UCLA Department of Economics.
  2. repec:oup:restud:v:58:y:1991:i:2:p:321-32 is not listed on IDEAS
  3. Ben S. Bernanke & Mark Gertler, 1995. "Inside the Black Box: The Credit Channel of Monetary Policy Transmission," Journal of Economic Perspectives, American Economic Association, vol. 9(4), pages 27-48, Fall.
  4. Farmer, Roger E.A. & Woodford, Michael, 1997. "Self-Fulfilling Prophecies And The Business Cycle," Macroeconomic Dynamics, Cambridge University Press, vol. 1(04), pages 740-769, December.
  5. Jordi Galí & Mark Gertler, 1998. "Inflation dynamics: A structural econometric analysis," Economics Working Papers 341, Department of Economics and Business, Universitat Pompeu Fabra.
  6. Benhabiv, J. & Farmer, R.A.E., 1991. "The Aggregate Effects of Monetary Externalities," Papers 164, Cambridge - Risk, Information & Quantity Signals.
  7. V. V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 1996. "Sticky Price Models of the Business Cycle: Can the Contract Multiplier Solve the Persistence Problem?," NBER Working Papers 5809, National Bureau of Economic Research, Inc.
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  9. Kenneth J. Matheny, 1998. "Non-neutral responses to money supply shocks when consumption and leisure are Pareto substitutes," Economic Theory, Springer, vol. 11(2), pages 379-402.
  10. Ball, Laurence & Romer, David, 1990. "Real Rigidities and the Non-neutrality of Money," Review of Economic Studies, Wiley Blackwell, vol. 57(2), pages 183-203, April.
  11. Obstfeld, Maurice & Rogoff, Kenneth, 1983. "Speculative Hyperinflations in Maximizing Models: Can We Rule Them Out?," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 675-87, August.
  12. Christiano, Lawrence J & Eichenbaum, Martin, 1992. "Liquidity Effects and the Monetary Transmission Mechanism," American Economic Review, American Economic Association, vol. 82(2), pages 346-53, May.
  13. Benhabib Jess & Farmer Roger E. A., 1994. "Indeterminacy and Increasing Returns," Journal of Economic Theory, Elsevier, vol. 63(1), pages 19-41, June.
  14. Miles S. Kimball & Michael Woodford, 1994. "The quantitative analysis of the basic neomonetarist model," Proceedings, Federal Reserve Bank of Cleveland, pages 1241-1289.
  15. Farmer, R.E.A., 1999. "Two New Keynesian Theories of Sticky Prices," Economics Working Papers eco99/33, European University Institute.
  16. Ascari, G., 1997. "Optimizing Agents, Staggered Wages and Persistence in the Real Effects of Money Shocks," The Warwick Economics Research Paper Series (TWERPS) 486, University of Warwick, Department of Economics.
  17. Benhabib, Jess & Rogerson, Richard & Wright, Randall, 1991. "Homework in Macroeconomics: Household Production and Aggregate Fluctuations," Journal of Political Economy, University of Chicago Press, vol. 99(6), pages 1166-87, December.
  18. Olivier Jeanne, 1997. "Generating Real Persistent Effects of Monetary Shocks: How Much Nominal Rigidity Do We Really Need?," NBER Working Papers 6258, National Bureau of Economic Research, Inc.
  19. Farmer, Roger E A, 1991. "Sticky Prices," Economic Journal, Royal Economic Society, vol. 101(409), pages 1369-79, November.
  20. Ascari, G. & Garcia, J.A., 1999. "Relative Wage Concern and the Keynesian Contract Multiplier," Economics Working Papers eco99/5, European University Institute.
  21. Lawrence J. Christiano & Martin Eichenbaum, 1990. "Current real business cycle theories and aggregate labor market fluctuations," Working Paper Series, Macroeconomic Issues 90, Federal Reserve Bank of Chicago.
  22. repec:cup:macdyn:v:4:y:2000:i:1:p:74-107 is not listed on IDEAS
  23. Farmer, Roger E. A., 1988. "What is a liquidity crisis?," Journal of Economic Theory, Elsevier, vol. 46(1), pages 1-15, October.
  24. Hoffman, Dennis L. & Rasche, Robert H. & Tieslau, Margie A., 1995. "The stability of long-run money demand in five industrial countries," Journal of Monetary Economics, Elsevier, vol. 35(2), pages 317-339, April.
  25. Benhabib, Jess & Bull, Clive, 1983. "The Optimal Quantity of Money: A Formal Treatment," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 24(1), pages 101-11, February.
  26. Kiminori Matsuyama, 1988. "Endogenous Price Fluctuations in an Optimizing Model of a Monetary Economy," Discussion Papers 813, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  27. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 1996. "Sticky price and limited participation models of money: a comparison," Staff Report 227, Federal Reserve Bank of Minneapolis.
  28. repec:cup:macdyn:v:1:y:1997:i:4:p:740-69 is not listed on IDEAS
  29. Farmer, Roger E. A., 1992. "Nominal price stickiness as a rational expectations equilibrium," Journal of Economic Dynamics and Control, Elsevier, vol. 16(2), pages 317-337, April.
  30. repec:oup:restud:v:57:y:1990:i:2:p:183-203 is not listed on IDEAS
  31. Calvo, Guillermo A, 1979. "On Models of Money and Perfect Foresight," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 20(1), pages 83-103, February.
  32. Brock, William A, 1974. "Money and Growth: The Case of Long Run Perfect Foresight," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 15(3), pages 750-77, October.
  33. Woodford, Michael, 1994. "Monetary Policy and Price Level Determinacy in a Cash-in-Advance Economy," Economic Theory, Springer, vol. 4(3), pages 345-80.
  34. Julio J. Rotemberg & Michael Woodford, 1999. "Interest Rate Rules in an Estimated Sticky Price Model," NBER Chapters, in: Monetary Policy Rules, pages 57-126 National Bureau of Economic Research, Inc.
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