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The evolution of cash transactions : some implications for monetary policy

  • Stacey L. Schreft
  • Bruce D. Smith

This paper considers the implications for monetary policy of a decreasing demand for outside money. It finds that even perpetual declines in the demand for base money pose no threat to the traditional methods employed for conducting monetary policy. The effects of such reductions in the demand for central bank liabilities, however, do depend on how monetary policy is conducted. Four monetary policy regimes are analyzed. With a policy of nominal-interest-rate targeting, a secular decline in the volume of cash transactions unambiguously leads to accelerating inflation. A policy of maintaining a fixed composition of government liabilities leads to accelerating (decelerating) inflation if agents have sufficiently high (low) levels of risk aversion. Inflation targeting produces falling nominal and real interest rates, while a policy of fixing the rate of money growth can easily lead to indeterminacy and endogenous oscillation in interest rates. It is argued that a policy of fixing the composition of government liabilities has several advantages if it is known that agents are not too risk averse and that the asymptotic demand for base money is small. If this information is not known, then interest-rate or inflation targeting have an advantage because their consequences are not sensitive to such environmental features.

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Paper provided by Federal Reserve Bank of Kansas City in its series Research Working Paper with number 99-02.

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Date of creation: 1999
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Handle: RePEc:fip:fedkrw:99-02
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  1. Stephen D. Williamson, 1995. "Discount Window Lending and Deposit Insurance," Macroeconomics 9504001, EconWPA, revised 18 Apr 1995.
  2. Gordon H. Sellon, Jr. & Stuart E. Weiner, 1996. "Monetary policy without reserve requirements: analytical issues," Economic Review, Federal Reserve Bank of Kansas City, issue Q IV, pages 5-24.
  3. Bruce Champ & Bruce D. Smith & Stephen D. Williamson, 1996. "Currency Elasticity and Banking Panics: Theory and Evidence," Canadian Journal of Economics, Canadian Economics Association, vol. 29(4), pages 828-64, November.
  4. Schreft, Stacey L. & Smith, Bruce D., 1997. "Money, Banking, and Capital Formation," Journal of Economic Theory, Elsevier, vol. 73(1), pages 157-182, March.
  5. Michael Woodford, 1997. "Doing Without Money: Controlling Inflation in a Post-Monetary World," NBER Working Papers 6188, National Bureau of Economic Research, Inc.
  6. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
  7. Stacey L. Schreft & Bruce D. Smith, 1995. "The effects of open market operations in a model of intermediation and growth," Working Papers 562, Federal Reserve Bank of Minneapolis.
  8. Townsend, Robert M, 1987. "Economic Organization with Limited Communication," American Economic Review, American Economic Association, vol. 77(5), pages 954-71, December.
  9. Ireland, Peter N., 1994. "Economic growth, financial evolution, and the long-run behavior of velocity," Journal of Economic Dynamics and Control, Elsevier, vol. 18(3-4), pages 815-848.
  10. Greenwood, J. & Smith, B.D., 1995. "Financial Markets in Development, and the Development of Financial Markets," RCER Working Papers 406, University of Rochester - Center for Economic Research (RCER).
  11. Schreft, S L, 1992. "Transaction Costs and the Use of Cash and Credit," Economic Theory, Springer, vol. 2(2), pages 283-96, April.
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