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Role of monetary policy in economic growth and development: from theory to empirical evidence

Asian Journal of Economics and Banking

ISSN : 2615-9821

Article publication date: 11 May 2022

Issue publication date: 24 March 2023

This article examines the effects of credit to private sector on the business and trade activities. The effectiveness of rapid expansion in public and private borrowing through state's intervention after COVID-19 pandemic has been assessed in this study.

Design/methodology/approach

The model to determine the role of credit expansion is based on four equations estimated through panel least square technique on 18 years data of 186 countries.

It is concluded that credit to private sector and external debt improve the investment in infrastructure, which is a significant determinant of gross domestic product growth. Empirical evidences corroborate that higher number of firms using banks to finance their investment and the volume of broad money determine the magnitude of credit to private sector.

Originality/value

This study explores some new evidences and aspects of the credit financing which have not been discussed in this way before.

  • Public private partnership
  • Financial inclusion
  • Domestic credit to private sector
  • Neoclassical liberalism
  • Ordoliberalism
  • Panel least square

Mehar, M.A. (2023), "Role of monetary policy in economic growth and development: from theory to empirical evidence", Asian Journal of Economics and Banking , Vol. 7 No. 1, pp. 99-120. https://doi.org/10.1108/AJEB-12-2021-0148

Emerald Publishing Limited

Copyright © 2022, Muhammad Ayub Mehar

Published in Asian Journal of Economics and Banking . Published by Emerald Publishing Limited. This article is published under the Creative Commons Attribution (CC BY 4.0) licence. Anyone may reproduce, distribute, translate and create derivative works of this article (for both commercial and non-commercial purposes), subject to full attribution to the original publication and authors. The full terms of this licence may be seen at http://creativecommons.org/licences/by/4.0/legalcode

1. Introduction: effectiveness of monetary policy

Monetary policy is considered a part of economic planning and strategies to provide an environment for economic development and welfare of general public. A usual way to test the effectiveness of monetary policy is to test the impacts of interest rates on gross domestic product (GDP) growth, investment and inflation. The traditional Liquidity-money (LM) curve approach is also adopted to explain the implications of monetary policy.

For a desirable outcome of monetary policy, the nominal rate of GDP growth should not be less than the rate of inflation. If the effect of monetary easing on inflation is stronger than its effect on growth, it will lead to higher level of poverty. In other words, a positive real rate of growth in GDP is the indicator of an effective monetary policy. This target can be achieved if monetary expansion leads the enhancement in business activities. The volume of external trade and creation of new business entities are the indicators of enhancement in business activities, while a higher rate of GDP growth can lead to alleviation of poverty. Baily and Okun (1965) have concluded that higher economic growth in terms of GDP reduces the unemployment.

Mehar (2018a , b) has analyzed the effects of monetary policy on poverty. The accelerated growth in investment and control over inflation are the twin objectives of a monetary policy while growth in investment is closely related to the creation of employment opportunities. Any policy instrument which affect the inflation or unemployment will also affect the level of poverty, because magnitude of poverty is determined by the level of unemployment and inflation.

In fact, the effectiveness of monetary policy depends on the utilization of domestic credit to private sector in enhancement of economic and business activities. Mehar (2011) has identified several mechanisms that make monetary policy a regressive option to manage the economy. According to this approach, the most important regressive option is the interest rate spread. A higher rate of interest can lead to the cost push inflation if producers use the debt financing to run their production process and inventory holding. The interest on borrowing from commercial banks to manage the working capital requirements can be included in the cost of production which is a source of cost push inflation ( Mehar, 2018a , b ). The availability of raw material for some industries depends on crop seasons – like sugar, textile, tobacco and food. But, their sales activities are spread over the year. Such industries prefer to adopt working capital financing from banking sector. This situation can lead a higher rate of inflation if interest rate increases. The peoples in lower income groups will be the net looser, if such products are commonly used.

Monetary policy is also a key determinant of investment. The interest rate for lending from commercial banks and the easy access to credit are the components of monetary policy which determine the magnitude of investment.

The growth in credit to private sector improves the market liquidity, which plays an important role in determination of investment. Some studies have defined the market liquidity as a residual of the change in money supply after deduction of public borrowing and time deposits. This liquidity is generated through individual savings, corporate retained earnings, investable funds in financial institutions and inflow of foreign investment.

Fiscal policy is considered also an option to enhance the business activities. However, fiscal support by the government to private sector can generate fiscal deficit, which may be a cause of growing public debt. Consequently, the gilt-edged securities offered by the government to finance its fiscal deficit can divert the investable funds from private equities to government securities. An attractive interest rate on gilt-edged securities creates a selling pressure in equity market which leads to decline in the value of common stocks issued by the companies in private sector. It implies ineffectiveness of fiscal policy because of crowding out effect. Another important aspect of the excessive use of fiscal policy is the borrowing from commercial banks to finance fiscal deficit. Though, it provides an easy option to banks to lend public money to the government, which is the safest option from the bankers' point of view. Moreover, it provides handsome risk-free rate of return to the banks. Though, it reduces the banks' ability to provide credit to private sector.

The higher tax collection by the government to reduce its fiscal deficit may adversely affect the economic growth. The taxes on commodities (general sales tax, excise and import duties) are a usual way to enhance the tax collection. The higher rate of inflation is a natural outcome of such taxes. A report released by Fiscal Policy Department of IMF ( Gupta, 2014 ) stated that some taxes levied on wealth, especially on immovable property, are also an option for economies seeking more progressive taxation. However, it has been observed that policy makers prefer to indirect taxes. It is observed that international financial institutions including International Monetary Fund (IMF) emphasize in enhancing the tax-to-GDP ratio to finance the fiscal deficit ( Mehar, 2005 ). Surprisingly, the IMF does not pay considerable emphasize on the monetary policy in its recommended demand management measures, though its primary concern is closely related to the monetary system.

2. Theoretical background and review of literature

Before evaluation of the effects of the state's involvement in money, banking and credit policies, it seems important to review the history of theoretical development in political economy of money, banking and credit.

Keynesian's macroeconomics policies are broadly divided into three eras: (1) the era based on Keynes' ideas initiated in the 1940s; (2) the monetarist era, associated with the work of Milton Friedman, after failure of Keynesian's ideology in some cases in 1970s and (3) a combined approach of both Keynesians' and Monetarists' ideologies since late 1990s. The effectiveness and limitations of monetary and fiscal policies have been debated in economic literature. The role of monetary policy in economic growth and development has been widely discussed in economic literature. The determination of interest rate, access to credit financing, size of financial inclusion in the economy, volume of the credit to private sector, effects of monetary policy on inflation and GDP growth and effects of interest rate spread on income distribution are included in those topics which have been debated in academic literature. Some new dimensions of monetary policy have been observed during COVID-19 crisis; one of those is the expansion in soft credit policies by banking sector in different countries. One of the common measures which has been adopted by almost every country during the pandemic crisis is the softness in lending to private sector and use of public money to support the business activities.

The interaction of monetary policy, external borrowing and supply of credit to private sector in the context of COVID-19 pandemic have been examined by World Bank (2020) , IMF (2020a , b) , Durrani et al. (2020) , Smith (2020) , Krugman (2020) , Rogoff (2020) , Case and Deaton (2020) , Mehar (2021) and Nemoto and Morgan (2020) . Mehar (2021) has derived a mathematical model to device a criterion to assess the sustainability of external financing. Now, The Economist (2020b) and University of Cambridge (2020) have indicated the beginning of a new era after COVID-19 pandemic. It was advised ( The Economist, 2020a , c ) that governments should find the right path between stimulus and restraint. According to Krugman (2020) , “There will be a hangover from borrowing but it should not pose any major problems.” Rogoff (2020) mentioned that economic catastrophe due to COVID-19 pandemic is likely to rival or exceed that of any recession in the last 150 years. He suggested that governments should inject heavily into the economy. Shirai (2020) has described that the crisis stimulated many central banks to implement substantial monetary easing along with massive fiscal stimulus measures. The central banks in various countries urged the commercial banks to keep lending because reduction in lending will lead to bankruptcies of different businesses which will come back to hurt the banks.

Another important aspect of monetary policy is the use of financial technology for monetary transactions. Haddad and Hornuf (2019) and Foroohar (2019) have identified the limitations and adverse aspects of the uses of financial technology. The use of financial technology covers a broad area from digital currencies, mobile phone wallets, cryptoassets, online remittances, Internet banking, online brokers, robo-advisors, cryptoasset trading, mobile trading to alternative finances through crowd funding, peer-to-peer lending, online balance sheet lending and supply chain finance. According to Marlene et al. (2019) , “fintech” is an advanced technology to improve and automate delivery and use of financial services to consumers and businesses. Gormez (2019) mentioned that electronic money is not a new concept, and technology can enhance the way of dealing, but does not change the fundamental nature. He claims that central banks that have perfectly addressed all the fundamental glitches of money and financial service provision can issue digital currencies with no reluctance. Mehar (2021) found that higher share of population receiving payments by digital modes and the use of the Internet for payments of bills or to buy something online are significant and robust determinants of trade in services. Stijn et al. (2018) mentioned that fintech may improve the efficiency of financial intermediation and provide a substitute funding source for businesses and consumers. Xu and Xu (2019) have explained how the government of China has regulated peer-to-peer (P2P) lending, third-party payment and cryptoassets. Some important aspects of the relations between money, income and payment system have been analyzed by Polak (1957) .

3. Policy intervention for economic growth and development

The philosophy of capitalism supports the assumption of trickle down transfer of resources from top to bottom level. This assumption has justified facilitation to private sector to ensure the continuity of business activities during COVID-19 pandemic. But, it is another reality that the pandemic has affected the different types of businesses in different ways as an increase of more than US$25bn was observed in the worth of top 100 companies ( Mehar, 2021 ). The Financial Times (2020) has classified the pharmaceutical, cloud computing, e-commerce and gaming as winning sectors. Some analysts have expected that the greatest wealth transfer in history will take place over the next three years. Even during the Great Depression, when one-third of Americans were financially devastated, more millionaires were created at that point in time than at any other time in American history ( Gunderson, 2020 ).

Since the financial crisis of 2008, the debate on the state's involvement in banking has become an important topic in political economy and global financial architecture. The debate has gained momentum after COVID-19 crisis when governments have intervened in the lending from commercial banks and the quantitative easing (QE) in monetary policy was adopted by majority of the central banks. To facilitate the private sector, governments have compromised on their tax revenue targets and spending on infrastructure development, while growing deficits have accelerated the rapid expansion in debt financing. The government intervention to protect the private businesses has damaged the targets of sustainable development goals (SDGs) and investment in environmental, social and governance (ESG) projects. While spending on ESG- and SDGs-related projects can play a critical role in eradication of poverty and reducing the income inequalities, the global financial crisis spurred a widespread movement to rethink excess capitalism and overemphasis on profits ( Nemoto and Morgan, 2020 ).

The state's involvement in private businesses was always an important debate in political economy. This debate became more important after fiscal and monetary interventions by several governments in developed and developing countries to manage the effects of COVID-19. The governments all over the world have intervened in private business activities through tax exemptions, subsidies, QE in monetary policies, lowering interest rates, decline in cash reserve ratios and enhancing credit to private sector. However, some analysts think that involvement of state to support some businesses and bail out packages to some industries facilitates the transfer of wealth to some businesses ( Gunderson, 2020 ). The involvement of government is nothing more than the creating a way for utilization of money of some peoples for the benefits or protection of other peoples. Though, utilization of this money for the protection of other peoples may be more beneficial ultimately for the depositors. The legitimacy of government's action to influence the use of depositors' money for protection and promotion of other businesses is transformed through monetary policy. What should be the criterion to determine the role of government in using the public money in commercial banks for protection and promotion of other businesses? Obviously, the intervention by monetary policy will be justified if accelerated credit to private sector promotes the creation of new business entities and trade activities.

What should be the criterion to determine the limitation of state in using the public money in commercial banks to finance the development expenditures and protect the market economy? The “Anglo-Saxon Capitalism” and “German Neoliberalism” provides different responses. The Anglo-Saxon Capitalism which is the representative of Adam Smith's classical economics is practiced in the United Kingdom, the USA, Canada, New Zealand, Australia and Ireland, favors the low level of regulations, low taxes, provision of few essential services by public sector, strong private property rights, contract enforcement and overall ease of doing business and low barriers to free trade. In its present shape it is based on the Chicago School of Economics. The neoclassical economic liberalism in American and British economies is its one of the extreme versions. The underlying assumption of this version is that the inherent selfishness of individuals is transferred by the self-regulating market into general economic well-being. In neoclassical economic liberalism, competitive market should function as equilibrating mechanisms, which deliver both economic welfare and distributive justice. An important point of the economic liberalism is that government should regulate economic activity, but the state should not get involved as economic actor.

The “Ordoliberalism” or “German Neoliberalism” emphasizes the need for the state to ensure that the free market produces results close to its theoretical benefits. Ordoliberals suggest a strong legal system and suitable regulatory framework to ensure that market functions effectively. According to this version, unequal powers of the stakeholders can eliminate the competition in market. The cartels and monopolies can abolish the advantages of free market. So government interference is required to maintain market freedom. It implies that the freedom of markets from government intervention (laissez-faire) is different from the freedom of individuals to compete in markets (liberalism). According to Ordoliberals the main enemy of free society is monopolies instead of the state. So, they oppose creation of monopolies through protectionism, subsidies or cartels. The difference between “Neoliberalism” and “Ordoliberalism” is also described as the difference between a liberal market economy and a coordinated market economy.

Various justifications and perceptions of state intervention in the economy lead to policy differences and then these policies influence the relationship between the public and private sectors. The process and instruments of monetary and fiscal policies including tax rates, tax-to-GDP ratio, public sector development expenditures, subsidies and intervention of government in determination of interest rates, exchange rates and segmentation of the credit to private sector determine the patterns of economic growth and investment. However, a global inclination to “Neoclassical Liberalism” is reflected in the governments' policies in post-COVID-19 world. To manage the rate of interest, expansion in credit to private sector, protectionism, subsidies and participation of state in infrastructure development are the ingredients of “Neoclassical Liberalism”.

Now, the global ranking of countries in their economic growth and development will be changed, depending on the growth and survival of the businesses in post-pandemic environment. The sustainability of existing businesses and the adoption of the required procedures in the new scenario require the survival and continuity of business activities which are closely related with the provision of financing to maintain liquidity and working capital requirements ( Mehar, 2022 ). In this scenario, the involvement of state to facilitate some businesses and bail out packages to some industries may be considered a part to reshuffle the rankings of earnings and wealth. The important question is the net effect of state's involvement on various kinds of businesses and groups in the society. Some analysts consider that the involvement of government is nothing more than creating a way for utilization of money of some peoples for the benefits or protection of other peoples. The peoples' money may be in the form of taxes or their deposits in banks and nonbanks financial institutions. However, it is quite possible that utilization of this money by the government for the protection of other people may be more beneficial ultimately for the depositors and tax payers. The legitimacy of government to utilize those money and its broader consequences is the primary question in this discussion.

Based on the above-mentioned discussion, we established a hypothesis that monetary intervention affects the economic growth and development positively. In this way, we examined the theory that growth in money supply provides an effective strategy for economic growth. The economic growth has been taken in term of GDP growth while economic development is indicated by investment in infrastructure through public-private partnership (PPP). So, this study tests the effectiveness of state's involvement in monetary, banking and credit policies for economic growth and development. The magnitudes of financial inclusions, real interest rate and credit to private sector from banks and other financial institutions have been considered as indicators of monetary policy. The role of state intervention in monetary policy will be justified if effectiveness of these policy devices is accepted. The effectiveness of these policy devices has been tested through empirical evidences in this study. The next section of this paper depicts the economic positioning and investment financing in Central Asia Regional Economic Cooperation (CAREC) and Economic Cooperation Organization (ECO) member countries. The theories regarding the justification and limitation of state's intervention in economic policies have been briefly discussed in this section. Section 5 establishes the models and methodology for empirical testing. Section 6 explains the empirical finding and statistical evidences, while conclusions and some policy implications have been described in section 7 .

4. Leverage financing and monetary policy in CAREC and ECO member countries

The study focuses specially on the member countries of CAREC and ECO. Historically, these countries have experience in using state's intervention in monetary policies for economic growth and development. This study provides also a comparison of these countries with the rest of the world. Further, examining the effectiveness of monetary policy in post-Soviet regime can assess the success of classical economic tools in these countries. So, it can add some new knowledge in the existing literature of economic policies in Central Asian countries.

The patterns of economic growth, investment in infrastructure on PPP basis, external debts and monetary policy indicators have been shown in Tables 1–3 . An objective of these tables is to show the trends of economic and monetary policy indicators before the COVID-19 crisis. A comparison of monetary policies and debt financing reveals the limitations of monetary and credit policies in CAREC and ECO member countries. A bird's eye view of GDP growth, investment in infrastructure on PPP basis, inflow of foreign investment, outstanding debts and monetary policy indicators shows a big variation in the monetary and credit policies in these countries.

These patterns show the diversification in monetary and credit policies among the countries in the region. Another notable point is the lower magnitude of the “credit to private sector as percentage of GDP” in these countries (except China). These countries are far behind in provision of the “domestic credit to private sector” as compared to the world's average (even far behind as compared to middle income countries). The share of short-term borrowing in total external borrowing is higher in China and Iran but other countries heavily rely on long-term debts.

Though, there is a large variation in GDP growth rates among the CAREC and ECO member countries, their rates of growth are higher than world average (except Iran and Turkey). Investment in infrastructure on PPP basis is still a weak area in CAREC member countries except China, while in Western world [including USA, Canada and European Union (EU)] it is completely a private sector activity.

A rapid growth in external debt has been shown in Table 2 ; it is envisaged that large part of external debts of Azerbaijan and Pakistan belong to their public sectors. The most important observation related to the monetary policy is the lower credit to private sector in CAREC member countries (except China). It is lowest in Afghanistan, Pakistan and Tajikistan. The credit to private sector as percentage of GDP in 2019 was 3.2 in Afghanistan, 11.6 in Tajikistan and 18.1 in Pakistan. It was less than 70% in other CAREC member countries, while the world average is 132%. It is an indicator of the inactiveness of banks and credit policy in these economies. The less inclusion of individuals and firms in financial system and the lower magnitude of broad money may be causes of lower magnitude of credit to private sector. Certainly, broad money includes long-term public deposits in commercial banks which is a factor of banks' credit to private sector.

The historical role of state's intervention in monetary policy for economic growth and infrastructure development in CAREC members and some other developing countries has become more justifiable when high income countries have intervened in economic policies to mitigate the severe adverse effects of the spread of COVID-19 pandemic. The monetary and fiscal incentives to private sector and external borrowing by public sector to set off their growing fiscal deficit are those strategies which have been adopted by the governments in developed and developing countries all over the world.

In consequence of such policies, the US budget deficit has expanded to US$4 trillion due to stimulus packages. EU has announced a US$2 trillion plan to fight the impact of coronavirus over the next seven years. Almost half a million companies in Germany have sent their staff on short-term working scheme – known as “Kurzarbeit”. German government has to spend more than EURO 10bn for this scheme. Due to these policies, the IMF (2020a , b , c) has predicted growth in fiscal deficit about 5% points of GDP, on average. Some countries and financial institutions have to rely on external financing; in this case the repayment of unhistorical debts will become a crucial issue. Previously, the largest, fastest and most broad-based increase in debts of developing and emerging countries was observed by Kose et al. (2020) . After the pandemic, the debt will further increase rapidly, which can lead a financial crisis. However, Krugman (2020) , Rogoff (2020) and Mehar (2021) have insisted the debt financing for economic survival. Mehar (2021) has provided a mathematical model to device a criterion to assess the sustainability of external financing.

Other than growing fiscal deficit and external borrowing, the enhancement in credit to private sector from banks and financial institution was a policy instrument which was adopted by the countries all over the world. A rapid increase in financial inclusion was observed all over the world after the pandemic crisis. The banks and financial institutions have introduced user-friendly policies for firms and individuals to use their services. The monetary policy authorities have played a major role in introducing such soft polices. The objective of enhancing financial inclusion and lower rate of interest was the augmentation in credit to private sector. Many central banks have implemented substantial monetary easing. Consequently, growing number of central banks have faced the effective lower bound (or even zero) in their policy rates. The Bank of England, central banks in the Eurozone, Japan, USA, Australia, Canada and New Zealand are included in these banks. The central banks in Brazil, Chile, Columbia, Hungary, Indonesia, the Philippines, Poland, the Republic of Korea, Romania, South Africa and Turkey have also adopted QE ( Shirai, 2020 ). The ease of monetary policy was adopted also by CAREC member countries. The State Bank of Pakistan has reduced the prime rate of interest by more than 5%, which was the largest decline in history of the country.

The expansion in public and private sectors borrowing may lead to a debt crisis. One of the important questions related to this debate is the impact of credit enhancement on economic and development. In the next section, we established a model to assess the impact of credit to private sector on GDP growth and investment in infrastructure. Here, it is important to mention that change and development of infrastructure will be required in the post-COVID-19 scenario. The countries and regions that can manage to change and develop their infrastructure according to the new requirements will be ranked at the higher level in global economic ranking. Despite the required change and development in infrastructure, the majority of governments in present scenario are focusing to meet their recurring expenditures to finance health facilities, subsidies to private businesses and stipends to poor families. The lack of compatible infrastructure in future can lead to further deterioration in economic growth. To attract private sector for investment in infrastructure is one of the options.

Here it is notable that the state involvement in development financing by private sector is known as “PPP”. The public partnership in infrastructure development projects is required despite the private investment. The question regarding the state's involvement in PPP for investment in infrastructure will not be valid if state's participation is limited only for maintaining the law and order situation to protect the infrastructure, and providing guarantees for recovery of user charges, fees or taxes for the use of infrastructure. The government support is required for such long-term heavy investment in infrastructure-related projects.

The credit to private sector may provide financing facilities to infrastructure related projects. Though, monetary policy by the central banks plays an important role in allocation of the credit facilities to different sector and determination of the rate of interest, the banks' ability to lend is determined by other factors also. This study also identifies the determinants of the credit to private sector. It was tested that how real rate of interest and firms and individual inclusion in financial system contribute in augmentation of credit to private sector.

5. Determination of growth, investment and credit to private sector: estimation methodology

In the light of above-mentioned background, a model to determine the role of monetary policy intervention in economic growth and development has been established in this study. The monetary policy intervention in this model has been measured by the magnitude of overall domestic credit to private sector, while tax revenue to GDP ratio reflects the fiscal policy influence. It is supposed that magnitude of the credit to private sector is influenced by qualitative and quantitative measures adopted by the monetary policy authorities. To regulate an indicative (prime) interest rate, setting a mandatory reserve requirement for commercial banks, enhancing financial inclusion of firms and individuals by easing regulatory and procedural requirements and enhancing broad money through attractive schemes by commercial banks to boost their deposits are the discretionary measures which can enhance the size of credit to private sector. It is hypothesized in this study that financial inclusion and broad money influence the size of domestic credit to private sector. We tested the role of domestic credit to private sector, tax-to-GDP ratio, investment in infrastructure on PPP basis, external outstanding debt and foreign direct investment (FDI) in determination of GDP growth. The investment in infrastructure is another indicator of economic development. The determinants of investment in infrastructure have also been explained in the model. How GDP growth and investment in infrastructure will be affected by monetary intervention, it has been tested empirically. The monetary policy intervention will be justified if intervening variables significantly affect the economic growth and development. Figure 1 explains the interaction of investment in infrastructure on PPP basis, domestic credit to private sector, external long-term debt, short-term debt, tax-to-GDP ratio, financial inclusion and FDI. The model is based on four equations, while GDP growth has been taken as targeted variable which can be written in the following linear form: G R O W it = β D C P S it + γ P P P I it + δ X it + μ i + τ t + ε it where “ GROW it ” is annual growth in “Gross Domestic Product (GDP)” for country “ i ” in year “ t ”; “ DCPS it ” and “ PPPI it ” are vectors of variables related to “Domestic Credit to Private Sector” from banks, nonbanking financial institutions and other sources including public-sector enterprises and “Investment in Infrastructure on Public Private Partnership” basis, respectively; “ X it ” is a vector of exogenous control variables; “ µ i ” denotes unobserved time-invariant heterogeneity at the country level; “ τ t ” is a time-fixed effect and “ ε ijt ” is an independent disturbance term.

The theoretical framework employed constitutes the relations between the growth in GDP and the domestic credit to private sector through different channels. It can be described as follows: GRO W it = f ( DCP S it ,   PPP I it ,   FD I it ,   ×   DB T it ) where “ PPPI ” is the investment in infrastructure through PPP. Relating GDP growth to the aforementioned factor, both the estimated direct and indirect effects can be expressed as follows: d G R O W d D C P S = ∂ G R O W ∂ D C P S + ∂ G R O W ∂ P P P I . ∂ T P P P I ∂ D C P S

To estimate the impacts of explanatory factors on GDP growth (GROW), investment in infrastructure on PPP basis (PPPI) and domestic credit to private sector, the following equations have been established: (1) G R O W i t = ∝ i + β 1 D C P S G i t + β 2 P P P I i t + β 3 T X G D P i t + β 4 F D I G D P i t + β 5 X D B T i t + β 6 S T D B T i t + β 7 H I G H i + β 8 C A R E C i + ε i t (2) P P P I i t = ∝ i + β 1 D C P S G i t + β 2 F D I N E T i t + β 3 D B T P B L i t + β 4 S T D B T i t + β 5 H I G H i + β 6 C A R E C i + ε i t (3) D C P S i t = ∝ i + β 1 B M O N E Y i t + β 2 B N K B R W R i t + β 3 B N K F R I N V i t + β 4 I N T R E A L i t + β 5 D S V N G i t + β 6 T R D i t + β 7 W E A L T H i + β 8 R E C E S S I O N t + ε i t (4) B C P S i t = ∝ i + β 1 B M O N E Y i t + β 2 B N K B R W R i t + β 3 B N K F R I N V i t + β 4 I N T R E A L i t + β 5 D S V N G i t + β 6 T R D i t + β 7 W E A L T H i + β 8 R E C E S S I O N t + ε i t

In the first equation, it is hypothesized that growth in GDP (GROW) depends on the size of domestic credit to private sector as percentage of GDP (DCPS), tax-to-GDP ratio (TXGDP), inflow of FDI as percentage of GDP (FDIGDP), external debt (XDBT), short-term debt (STDBT) and investment in infrastructure projects on PPP (PPPI) basis. The tax-to-GDP ratio can affect the growth of GDP negatively. The domestic credit to private sector (DCPS) is a monetary policy indicator which reflects the availability of investable funds and liquid resources to the private sector. We have also introduced two dummy variables in these equations. The high income economies including USA, Canada, Japan, Russian Federation, China, Australia, New Zealand and countries in EU are included in the high income group (HIGH). The dummy variable for this category can capture the experiences of these economies in economic governance. A dummy variable which reflects the situation of PPP in member countries of the CAREC and ECO has also been introduced in the model (CAREC). The CAREC member countries have a historical background where private-sector participation in infrastructure projects was not common. Majority of countries in this set have been used to heavy dependency on public-sector funding to develop the physical infrastructure. The private sector investment for infrastructure development was not a popular way of financing in these countries.

The second equation in the model tests the impacts of domestic credit to private sector (DCPS), external debt to public sector (DBTPBL), net FDI (FDINET) and short-term debt (STDBT) on the investment in infrastructure on PPP (PPPI) basis. The dummy variable to capture the special economic background of CAREC member countries has also been incorporated in this equation. The “CAREC” is a dummy variable which is equal to “1” for those 13 countries which are members of the CAREC or the ECO.

Third and fourth equations determine the causal factors of overall domestic credit to private sector (DCPS) and domestic credit to private sector by banks (BCPS) as percentage of GDP. In these two equations we tested the impacts of broad money (BMONEY) and financial inclusion on the magnitude of domestic credit to private sector (DCPS and BCPS). The financial inclusion was measured by two variables: number of banks' borrowers for per 1,000 adults in a country (BNKBRWR) and the firm getting loans from financial institutions for investment as percentage of total firms (BNKFRINV). We have also tested the impact of the real interest rate (INTREAL) and aggregate domestic savings (DSVNG) on the size of domestic credit. Besides these explanatory variables, we introduced a dummy variable to capture the impact of aggregate national wealth in a country on the domestic credit. Aggregate national wealth is the total sum of the value of a nation's assets minus its liabilities. It refers to the total value of net wealth possessed by the citizens of a nation at a set point in time, while wealth is defined as the value of financial assets plus real assets (principally housing) owned by households, minus their debts ( Credit Suisse Research Institute, 2019 ). Seven countries (the USA, the United Kingdom, Japan, Italy, France, Germany and China) have been defined as wealthy countries. These countries cover more than 70% of global wealth in 2019. According to our selection criterion, a country is defined as wealthy country if its aggregate wealth is greater than US$10 trillion in 2019 and it is included in the list of top 15 wealthy countries for last ten years consecutively. The above-mentioned seven countries fulfill this criterion.

To test the impact of “German Neoliberalism (Ordoliberalism)” on investment in infrastructure based on PPP and GDP growth, a dummy variable (GERMANY) has been included in the model, which is equal to “1” for Germany and “0” for other countries. The other control variables are recession (RECESSION) which is equal to “1” for 2008 and 2009 and “0” otherwise. Aggregate trade as percentage of GDP (TRD) and gross domestic saving as percentage of GDP (DSVNG) are other control variables.

We have included various types of financing in these equations: external outstanding debt (XDBT), external public sector debt (DBTPBL), short-term debt (STDBT) and domestic credit to private sector (DCPS). Some specific characteristics and implications are attached with every type of loan. The short-term debt (STDBT) and domestic credit to private sector (DCPS) may be used as proxy of the availability of funds for working capital. We are interested to quantify their net effects.

We applied data of 186 countries for 18 years (from 2001 to 2018) which makes total observations of 1,674. This sample provide us an unbalanced panel data. This data allows us to apply panel least square (PLS) to estimate the parameters. Tables 4 and 5 depict the descriptive statistics and summarize the changes in the trends of these variables. To test the authenticity of the model, the relevant statistics have been shown in Tables 6–9 . We applied PLS techniques to estimate the effects of explanatory variables. However, data for some countries could not be included in the model because of unavailability of data on some indicators which are included in the analysis. Data for this analysis was extracted from the World Development Indicators' Data Bank ( World Bank, 2020 ). However, data on national wealth was extracted from Credit Suisse Research Institute (2019) .

6. Results and empirical findings

The results of regression analysis have been presented in Tables 6–9 . The robustness in estimated parameters have been checked by using the alternatives options, where some falsification tests have also been conducted. For this purpose some control variables have been included in the regression analysis. These results quantify the impacts of explanatory variables. The results indicate the significance of parameters and overall goodness of fit in the equations. However, some results are shocking and against the common intuitive.

It is concluded that GDP growth is significantly improved by the investment in infrastructure (PPPI), foreign direct investment (FDIGDP) and short-term debt (STDBT). However, tax-to-GDP ratio and external outstanding debt affect GDP growth negatively. The reasons are obvious; the higher tax revenues discourage the business activities while external outstanding debt emphasizes repayments of debts and interest. The interest and repayment of debts can affect the availability of funds for investment in a country. The results validate the previous findings and monetary theories in economic literature ( Baily and Okun, 1965 ; Tobin, 1969 ; Glichrist and Leahy, 2002 ). However, the negative impact of credit to private sector on GDP growth is shocking.

Two dummy variables to represent high income countries (HIGH) and the member countries of CAREC have been included in the first equation to explain GDP growth. The regression analysis shows that growth in CAREC member countries is relatively higher than rest of the world.

The investment in infrastructure based on PPP (PPPI) is significantly improved by domestic credit to private sector (DCPS), external outstanding debt (XDBT) and external public sector debt (DBTPBL). In determination of the investment in infrastructure, it is noted that impact of short-term debt (STDBT) is positively associated with debt to public sector (DBTPBL) but it is negatively associated with outstanding external debt. The domestic credit to private sector can improve the private investment in infrastructure which has been shown in the results of equation: 2 ( Table 7 ).

“German Neoliberalism (Ordoliberalism)” has not been classified as a significant factor of investment in infrastructure based on PPP, while its impact on GDP growth is also weakly significant. Moreover, the high income countries are negatively associated with the PPP model ( Table 7 ) which reflects the fact that infrastructure development in high income countries belong totally to private sector in those countries, where there is no need to implement a “public private partnership model”.

Broad money (BMONEY), number of banks' borrowers and number of firms using banks to finance investment are the indicators of inclusion of firms and individual in financial system. Their inclusion in financial system enhances the size of domestic credit. To reduce indicative (prime) rate of interest during a recessionary period is a common practice by monetary authorities all over the world. However, this study does not confirm the significant impact of the real rate of interest (INTREAL) and recessionary period (RECESSION) on the size of credit to private sector. Similar impacts have been found by Gormez (2019) and Stijn et al. (2018) .

It was hypothesized that financial inclusion plays an important role in determination of the size of domestic credit to private sector. The number of firms getting loans from banks and number of borrowers have been taken as indicator of financial inclusion. The significant and robust effects of these variables suggest that lending to private sector should not be concentrated; its diversification among the large number of borrowers enhances the size of credit to private sector. It confirms the findings by Gormez (2019) .

The factors of credit to private sector have been tested twice: Table 8 shows the impacts of factors on credit to private sector from all sources including banks, nonbank finance companies, private lenders and public sector organizations. Table 9 shows the impacts of causal factors on credit to private sector by banks only. Both equations show the similar results though magnitudes of parameters are different.

The dummy variable to indicate the aggregate wealth status of a country (WEALTH) is equal to “1” if a country's wealth is more than US$10 trillion in 2019 and country is included in top 15 wealthy countries consecutively for the last ten years – wealth of a country is defined as a summation of the financial and physical assets owned by the peoples. Its significant positive association with the credit to private sector describes that financial and physical assets owned by the peoples of a country improve the ability to provide credit to private sector.

The more important evidence is the negative impact of the expansion in domestic credit on GDP growth. But, simultaneous inferences indicates that investment in infrastructure development is significantly supported by domestic credit and long-term external debt by public-sector enterprises. The negative impacts of the credit to private sector and external debt on GDP growth can be converted into net positive effects through positive contribution of these explanatory variables in infrastructure investment. These results are consistent with Mehar (2001) .

7. Policy implications and limitations

The results of this study provide some very important and interesting policy implications. The primary objective of this research is to determine the effectiveness of growth in credit to private sector for economic development. The factors of growth in credit have also been identified. However, this study does not cover the policy shocks and short-term measures to manage the impacts of COVID-19 or other shocks.

The most important conclusion belongs to the role of domestic credit to private sector, which shows a significant negative and robust impact on GDP growth which seems surprising. However, the role of domestic credit in determination of investment in infrastructure is significantly positive and robust in all scenarios. It reveals that domestic credit to private sector is not transformed into GDP growth instantaneously; it improves investment in infrastructure which is a positive significant and robust determinant of GDP growth. The enhancement of domestic credit to private sector may create inflation in short term which is factor of lower GDP growth (in real term). However, the positive impact of credit to private sector on investment in infrastructure ensures the growth of GDP. The policy makers should be ensured and establish a mechanism that external and domestic debts must be invested in required infrastructure and productive assets. Otherwise, it will affect the growth negatively.

The growth of economy is directly linked to the investment in infrastructure, while growth in domestic credit can play a significant role in the enhancement of investment in infrastructure. To create a fiscal space for investment by public sector in developing projects is not a recommendable policy. It will lead to higher tax collection. The crowding out effect of public expenditures for development purposes will make government interference ineffective. Such efforts increase “tax-to-GDP ratio” which negatively affects the economic growth. It has been noted in this study that higher tax-to-GDP ratio affects GDP growth negatively.

The government intervention in banking to enhance the domestic credit during the recession has not been found significant. The size of credit to private sector is not enhanced during the recessionary periods; it is shifted from one to another category of borrowers based on the prioritization set by regulatory institutions. Even the real rate of interest is not a significant determinant of domestic credit. The most important monetary policy instrument is the enhancement in the number of borrowers: firms and individuals. The number of borrowers reflects the inclusion of firms and individuals in the financial system. The credit facilities should not be concentrated. The diversification of borrowers will lead to credit enhancement. It implies that banks should not play a role in creating wealth concentration or monopolies.

FDI affect GDP growth positively but its effect on investment based on public private partnership is negative. In fact, it substitutes the domestic private investment in infrastructure, however, its positive contribution in economic growth is confirmed.

research paper on monetary economics

Determinants of GDP growth

Growth and investment in CAREC and ECO member countries

Note(s): “ β ” indicates Coefficient; “ T ” indicates T -statistics; AIC = Akaike information criterion, D-W = Durbin Watson; GDP, gross domestic product; PLS, panel least squares

* p  < 0.1; ** p  < 0.05; *** p  < 0.01

Source(s): Author's calculations

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Mehar , A. ( 2022 ), “ Nexus of debt financing, investment and policy intervention: impacts of covid-19 pandemics on CAERC member countries ”, in Tudler , R. , Verbrke , A. , Piscitello , L. and Puck , J. (Eds), International Business in Times of Crisis , Emerald Publishing, (First Edition) , London , 2022 .

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Further reading

Amstad , M. , Huang , B. , Morgan , P.J. and Shirai , S. ( 2019 ), “ Introduction and overview ”, in Amstad , M. , Huang , B. , Morgan , P.J. and Shirai , S. (Eds), Central Bank Digital Currency and Fintech in Asia , Asian Development Bank Institute , Tokyo , 2019 .

Claessens , S. , Frost , J. , Turner , G. and Zhu , F. ( 2018 ), “ Fintech credit markets around the world: size, drivers and policy issues ”, BIS Quarterly Review , pp. 29 - 49 .

FORBES Magazine , August 2020 .

Corresponding author

About the author.

Dr Muhammad Ayub Mehar is associated with the Employers' Federation of Pakistan as Economic Advisor. He is serving as “Professor” in Iqra University, Karachi. He has completed several publications and working on various research assignments for Asian Development Bank Institute. He has served as Economic Advisor and Director General in the Federation of Pakistan Chambers of Commerce and Industry for seven years and as the Economic Advisor of the ECO Chamber of Commerce for two years. He is member of the core committee of Economic Freedom Network Pakistan and alumni of the International Academy of Leadership (IAF) Germany. In recognition of his expertise, the Technology Policy and Assessment Center at Georgia Institute of Technology acknowledged his membership in the distinguished panel of international experts for Indicators of Technology-based Competitiveness, which is a project of the US National Science Foundation, USA Government. He has written Pakistani version of the world famous book on liberal economics, Commonsense Economics: What Everyone Should Know About Prosperity .

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Modern Monetary Theory: A Solid Theoretical Foundation of Economic Policy?

  • Open access
  • Published: 25 May 2021
  • Volume 49 , pages 173–186, ( 2021 )

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  • Aloys L. Prinz   ORCID: orcid.org/0000-0002-9198-5292 1 &
  • Hanno Beck 2  

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This paper shows that so-called modern monetary theory (MMT) lacks a sound economic foundation for its far-reaching policy recommendations. This paper’s main contribution to the literature concerns the theoretical foundation of MMT. A simple macroeconomic model shows that MMT is indistinguishable from the Keynesian cross model, as well as a neoclassical macroeconomic model, even when taking account of money in the sense of MMT. This result is in stark contrast to the claims of MMT proponents. Accordingly, it is asserted that MMT is a fundamentally new theory of money and monetary economics. However, MMT is admittedly based on the functional finance concept of the 1940s and money is modelled as an accounting identity. In addition, the fundamental connection between government expenditures for goods and services and the steady state equilibrium value of the national income, the so-called fiscal stance, is a well-known result that is not only consistent with MMT. The interpretation of the fiscal stance, in combination with the accounting identity for money, is a major issue because an equilibrium condition should have a certain causal direction of effects. Based on this reading of the equilibrium condition, policy recommendations encompass the fiscal dominance of monetary policy via monetization of public debt, a job guarantee by the state, along with a so-called Green New Deal. According to the results of this paper, these policy recommendations cannot be justified with MMT.

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Introduction

Recently, a macroeconomic theory, modern monetary theory (MMT) (also dubbed modern money theory), has become a hot topic in United States (U.S.) politics. Stephanie Kelton, a proponent of this theory, was among the advisers of Bernie Sanders in the 2016 U.S. presidential campaign. Her contemporary, Alexandria Ocasio-Cortez, a popular member of the Democratic Party in the U.S., seems to also adhere to MMT. MMT offers politicians what they want most: a simple justification for policies they want to carry out. A case in point is active U.S. labor market policy. The U.S. public expenditures in this policy area are very low in comparison to all other countries of the Organisation for Economic Co-operation and Development (OECD) (Council of Economic Advisers,  2016 ). After the near meltdown of the financial system and the economic fallout of the coronavirus pandemic, attitudes towards active labor market and social policies might have changed. Therefore, MMT may provide a welcome academic justification for these policies. Moreover, the popularization of MMT through the blogosphere may have a profound effect on U.S. politics and economic policy in the 2020s and 2030s (Brady  2020 ).

A special feature of MMT and its policy recommendations is public debt. According to MMT, public expenditures can be financed by public debt or even by printing more money without negative economic side effects such as inflation, crowding-out of investments or national insolvency (Forstater  1999 ; Mosler  1998 ). The only precondition is that the respective state has its own currency. This is the most provocative conclusion of MMT proponents.

MMT is not a new theory that emerged from the financial crisis of 2008. Most of the policy recommendations can be found in the work of Lerner ( 1943 , 1944 , 1951 ), dubbed functional finance, as also mentioned by MMT proponents. The theory itself is Post-Keynesian and monetary. Post-Keynesian economics (Arestis  1996 ; Lavoie  2009 ) is the general heading for very different economic concepts and theories that rely on Keynesian economics, but that do not accept New Keynesian concepts (Dixon and Rankin,  1995 ). Meanwhile, economists of this tradition formed a group whose common feature is a so-called coherent financial stock-flow accounting framework (Godley and Lavoie,  2012 , p. 12, who also sketch the development of MMT; Nikiforos and Zezza,  2017 ). As will become clear in the following, ex post accounting identities play a crucial role in MMT.

Literature Review

Although there are a number of recent assessments of MMT, these contributions either do not contain a formal analysis (Brady  2020 ; Coats  2019 ; Epstein  2020 ; Hartley  2020 ; Newman  2020 ; Palley  2015a ; Skousen  2020 ) or the formal analysis is a bit too sophisticated to isolate exactly where the theoretical foundation of MMT fails (Palley  2015b ). Palley ( 2015a ) discussed the elements of MMT with Tymoigne and Wray ( 2013 ) concluding that what MMT adds to old Keynesian economics is wrong. Similarly, Skousen ( 2020 ) investigated the macroeconomics textbook on MMT by Mitchell et al. ( 2019 ) concluding that MMT is dangerous as its policies may provoke runaway inflation, and that it is not required as countries can reduce unemployment substantially without applying MMT policies. Brady ( 2020 ) summarized five cornerstones of MMT concerning the sustainability of very high public debt and refuted them with results from old and contemporary economic literature. Coats ( 2019 ) studied MMTs free-borrowing hypothesis for governments and argued that this radical view was based on the critical assumption that the natural rate of interest is zero. Hartley ( 2020 ) found that MMT might be a political movement rather than an economic theory, as long as there is no empirical evidence for its propositions on government debt and inflation-free money creation. The MMT critique of Epstein ( 2019 , 2020 ) is related to the existing institutions that are responsible for monetary and fiscal policy. According to Epstein, this institutional setting and the functioning of modern financial markets may seriously limit the implementation of MMT’s policy recommendations. Kashama ( 2020 ) assessed MMT from the viewpoint of macroeconomic stabilization in the eurozone. His conclusion was that the policy assignment to the governments and the central bank, with the central bank responsible for price-level stability, should not be changed, in stark contrast to MMT. Compared to these papers, this short contribution relates to the theoretical foundation of MMT at a very fundamental level.

This paper most closely resembles Palley ( 2015b ). Palley provided a sophisticated theoretical analysis of MMT from a Keynesian viewpoint. He demonstrated very clearly the basic Keynesian approach of MMT and argued that nothing of relevance was added that would justify the term MMT. In contrast to Palley ( 2015b ), this paper takes MMT seriously in the sense that a simple version of MMT is used to prove that it is identical to the Keynesian cross model. In the model, MMT’s approach of financing government expenditures by money creation is applied, showing that MMT’s interpretation of money does not change anything. MMT does not present a new theory of money, but only accounting identities. Moreover, the fundamental flaw in MMT is a misreading of the equilibrium condition of the underlying macroeconomic system. Far reaching policy recommendations, such as financing large-scale social policy expenditures by public deficits or printing money, do not seem to be justified on the basis of MMT. Moreover, information in the Online Supplemental Appendix shows that even in MMT, ex post Ricardian equivalence must hold true. This implies that money is neutral in the sense that it does not eliminate or mitigate the fiscal burden of government expenditures.

Simplest MMT Model: SIM

The following presentation of MMT in the simplest version (SIM) is based on Godley and Lavoie ( 2012 , pp. 61–72). SIM is interpreted as the basic model of MMT. Moreover, all subsequent extensions of the model inherit the characteristics of SIM. The notation in this presentation is somewhat modified (without any content change) to make it easier to compare SIM with the simplest Keynesian model in the next section. The disposable income of households, \({Y}_{d}\) , is given by:

where W is wage, \({L}_{S}\) is labor supply, and T is tax payments of households. Note that firms are not modelled explicitly, as is quite usual in very simple macroeconomic models. Implicitly, firms employ labor services of households to produce goods and services and they pay wages to the households as remuneration of labor services.

SIM has two behavioral equations. The first one is the tax function, T , defined by the government:

where t is the tax rate of a proportional wage tax. The second behavioral equation is the consumption function, C , of households:

where \(\alpha ,\beta\) are coefficients and \({M}_{HH-1}\) is money stock of households from the previous period. The consumption function in Eq. ( 3 ) depends on the disposable income, with α as the marginal propensity to consume and β as the influence of the money stock households hold from previous periods.

Money is created by the government via the public budget deficit:

where \({M}_{G}({M}_{G-1})\) is money creation of the government in the current (previous) period and G is government expenditures for goods and services. Equation ( 4 ) can be understood as the monetization of debt (Protopapadakis and Siegel, 1986 ; Thornton  2010 ). Instead of I-owe-you’s (IOUs), the government buys goods and services by creating its own money, also called outside money (Wray  2014 ). Money is defined here as an accounting measure, or “as a two-sided balance sheet phenomenon” (Bell  2001 , p. 151). Therefore, it cannot be said whether it is an asset or only a numeraire (for a discussion of the latter, see Otaki 2012 ).

Households adjust their holding of money as follows:

i.e., the difference between disposable income and consumption is equal to the change in money holding. Obviously, the difference between disposable income and consumption must be equal to households’ savings, S (note that S is not included in SIM). National income is given by the production of consumption goods and public goods:

Note that Eq. ( 6 ) is an ex post identity. Therefore, it is neither right nor wrong. In addition, there are no investments. The proceeds are distributed to the factor of production, i.e., the labor services of households: \(Y=W\cdot {L}_{D} \underset{}{\Rightarrow } {L}_{D}=\frac{Y}{W}\) , where \({L}_{D}\) is labor services demand.

Since the money created by the government (money supply) must be equal to the money holding of households (money demand), the public budget deficit is equal to the change in the stock of money and, hence, savings:

Put differently, this means (not contained in the SIM presentation of Godley and Lavoie,  2012 ):

Equation ( 8 ) is the implication of a standard economic circular flow model with government, where  \(S=I+(G-T)\) , if there are no investments (as is the case in SIM), i.e., \(I=0\) . Obviously, the equality of savings, money creation and public budget deficit is a consequence of the descriptive circular flow model of the economy. This demonstrates that no new theory of money is presented with SIM and, hence, MMT. Instead, Eqs. ( 6 ,  7 , 8 ) are ex post identities.

In a (long-run) steady state equilibrium, government expenditures must be tax financed in order to avoid so-called Ponzi-games:

with Y* as the steady state equilibrium national income. Rearranging the terms in Eq. ( 9 ) yields:

Equation ( 10 ) is called fiscal stance. Godley and Lavoie ( 2012 , p. 72) emphasized the importance of the fiscal stance as follows: “It [i.e., G / t ] plays a fundamental role in all of our models with a government sector, since it determines GDP (i.e., gross domestic product) in the steady state.” In MMT, the expression G / t (government expenditures divided by the tax rate) is considered causal for the equilibrium national income, Y* . Even in a larger model with government money and portfolio choice (Godley and Lavoie, 2012 , p. 99), the steady state solution collapses to Eq. ( 10 ) if the average interest rate on all government liabilities is zero (Godley and Lavoie, 2012 , p. 115). A further implication (not mentioned) of SIM is again an ex post identity:

This implication is consistent with the circular flow model of the economy since there are no investments in SIM: \(I=0 \underset{}{\Rightarrow }S=G-T, G=T\underset{}{\Rightarrow }S=0\) .

To summarize, the simplest model containing the main elements of MMT is based on the descriptive circular flow model of an economy, combined with a tax function defined by the government, and a consumption function. However, the conclusion suggests that government expenditures (in combination with the income tax rate) causally determine the equilibrium national income. Footnote 1 To understand SIM better, it is compared with the simplest Keynesian model (KEYSIM) in the following.

SIM Versus the Keynesian Cross, KEYSIM

The Keynesian cross model, or KEYSIM, can be considered the simplest Keynesian model of an economy. It can be found in any introductory macroeconomics textbook (Beck and Prinz, 2018 , p. 145–156). The KEYSIM is also based on Eq. ( 6 ), i.e., that national income can be used for private consumption, C , or public expenditures for goods and services,  \(G\; (Y=C+G)\) :

Moreover, the consumption function is given by:

i.e., consumption consists of an income-independent element, C 0 , and depends on disposable income, Y d , with α as the marginal propensity to consume. Disposable income is given by total income, Y , minus savings, S , and tax payments, T : \({Y}_{d}=Y-S-T\) , whereby the tax is again a proportional income tax:

Furthermore, in equilibrium, all government expenditures are financed via taxation so that \(G=T\) . Finally, since there are no investments, the circular flow model implies that savings are zero ( \(S=0\) ). Therefore, combining Eqs. ( 6 , 12 , 13 ) gives:

Solving Eq. ( 14 ) for the equilibrium national income, Y , yields:

Equation ( 15 ) deviates from Eq. ( 9 ) ( \(G=T=t\cdot {Y}^{*}=t\cdot W\cdot {L}^{*}\) ) that also determines the equilibrium value of government expenditures. According to Eq. ( 15 ), the value of government consumption is given by: \(G=t\cdot {Y}^{*}=t\cdot \frac{{C}_{0}}{(1-\alpha )(1-t)}\) . In SIM, Eq. ( 3 ) says \(C\left({Y}_{d},{M}_{HH-1}\right)=\alpha \cdot {Y}_{d}+\beta \cdot {M}_{HH-1}\) . For sake of simplicity, let

which is that part of consumption that is independent of current income. Note that the term \(\beta \cdot {M}_{HH-1}\) in the consumption function is the only innovation in SIM, in comparison to KEYSIM. Accordingly, Eq. ( 14 ) holds also in SIM:

The long-run steady state equilibrium national income with a balanced public budget reads according to Eq. ( 15 ). There is also no contradiction to the long-run steady state equilibrium of SIM in Eq. ( 10 ) ( \({Y}^{*}=\frac{G}{t}\) ) since this also implies in SIM:

which is identical to the value of government consumption in KEYSIM, as can be seen by multiplying Eq. ( 15 ) with the tax rate, t .

Hence, up to this point, SIM and KEYSIM are indistinguishable. However, the Keynesian cross is an oversimplification of the Keynesian model. In this paper, only the short run is considered. Extending the model requires the incorporation of price-wage adjustments with Philips-curves. In such an extended model, price-wage dynamics will lead back to the long-term equilibrium. In contrast, MMT models do not contain price-wage adjustments. It is unclear what role money would play in MMT concerning price-wage adjustments. In this respect, MMT cannot be compared with a Keynesian model as applied here.

In addition, even in a neoclassical world with fully flexible wages and prices, the equilibrium condition (that may be written as \({Y}^{*}=Y\) ) will hold. Nevertheless, in neoclassical theory, supply determines equilibrium output. Moreover, with fully flexible prices and wages, monetary policy determines nominal variables in equilibrium. Fiscal policy may change the composition of demand and the distribution of income as fiscal stabilization is not an issue. Hence, in effect, the above analysis is not only compatible with MMT and Keynesian theory, but also with neoclassical macroeconomic theory. Consequently, SIM (and MMT) is not wrong. Where then does MMT get it wrong?

Misreading the Equilibrium Condition

The key to understand MMT is reading the equilibrium result in Eq. ( 18 ). By simple algebra, this equation can be written as:

As an equation, it can be interpreted in several ways:

National income, Y* , is determined by the government via choosing expenditures, G , and tax rate, t .

National income, Y* , is determined by the income-independent part of consumption, \({C}_{0}=\beta {M}_{HH-1}\) , the marginal propensity to consume, α , and the tax rate, t .

National income, Y* , is the result of the aggregate demand in an economy.

The production side of national income, Y* , determines private and public consumption.

Aggregate production and aggregate demand are equal at the equilibrium national income of Y* .

All of these versions are of necessity correct, or at least not wrong, because there is no causality involved. Since both models share the same bases (i.e., the circular flow model of an economy, a tax function and a consumption function) and the same equilibrium condition (aggregate supply is equal to aggregate demand), they are indistinguishable. Moreover, it is clear that both models are of Keynesian origin because the supply side reacts passively to changes in aggregate demand. By assumption, aggregate demand determines (is causal for) national income.

The claim of MMT that government expenditures, financed by running a public deficit via the creation of money, determine (causally) national income constitutes a misreading of an equilibrium condition (i.e., reading the equation from right to left). However, an equation simply equates two sides of the equation and nothing else. The causality is externally added by the reader, as it were.

Figure  1 shows SIM in a circular flow diagram. According to MMT, government expenditures for goods and services, G , in combination with a public budget deficit financed by creation of additional money, Δ MG (i.e., that part of G not financed via taxation with the tax rate, t ), determines national income, Y* .

figure 1

Fiscal stance and national income determination. Source: Own depiction

However, as Fig.  1 demonstrates, all causal explanations of Y* are circular. The model contains not one, but two decision making units: the government and households. Therefore, both are causal (in an interdependent way) for the size of national income. Moreover, the model is built on ex post identities (i.e., on accounting identities) as Fig.  1 demonstrates.

Another proposition of MMT can be clarified with Fig.  1 . According to MMT, it is neither taxes nor borrowing that finance public expenditures, but the creation of fiat money (Forstater  1999 , citing Lerner  1951 ; Bell  2000 ). In Fig.  1 , this corresponds with \(G=\Delta {M}_{G}\) . This implies that T  = 0. However, even in SIM, the steady state equilibrium requires that the No-Ponzi-Game condition, G  =  T , holds true (Godley and Lavoie, 2012 , p. 71). In Fig.  1 , the circular flow between households and the government indicates the equivalence of taxes and fiat government money according to \(T=\Delta {M}_{G}\) . Insofar, taxation is a method to regulate the amount of money in the economic circuit (Tymoigne and Wray, 2013 ). However, this is only an ex post accounting identity. As indicated by Fritz Machlup, ex post identities are futile for policy conclusions:

“Macro-theorists have not always been careful and have repeatedly been misled into thinking they could deduce consequences from an ex post definition, for example, that they could deduce the effects of an increase in investment from the definitional equation Y = C + I. This is logically impossible, and therefore inadmissible in macro-theory and in micro-theory” (Machlup, 1963 , p. 120).

Furthermore, the misreading of the equilibrium condition of SIM is responsible for the policy recommendations. Equation ( 12 ) and all equations containing Y* are different versions of the same equilibrium condition (e.g., Eq. ( 15 )). Of course, static multipliers may be derived from Eq. ( 14 ). Since the basis of MMT is the old-school Keynesian cross model, changes in aggregate demand variables lead to certain static multipliers. In effect, that government expenditures may increase national income does not depend on a certain theory of money, but on the fact that such a model allows by assumption only demand-side effects. That is all one can say on fiscal policies in this model.

Figure  1 also sheds some light on the issue of inflation, which is not a problem according to MMT. Inflation only occurs when aggregate demand is larger than aggregate supply. If demand outstrips supply, the government can decrease money supply by increasing taxes. Figure  1 shows that there is no monetary theory in this model, no assumptions about the endogeneity of money supply, the role of excess reserves of the central bank, the role of the financial sector and people’s expectations concerning the effects of monetary policy. If, for example, people expect more inflation or taxes as a result of higher government debt, the simple results of the SIM may not hold.

Figure  1 also shows another flaw of MMT. It neglects the role of the foreign sector. MMT assumes that as long as a country does not borrow in a foreign currency, it cannot default. This is certainly true, but most countries do not have the exorbitant privilege (Eichengreen  2011 ) of issuing a reserve currency. They have no choice but to borrow in foreign currencies. This aspect of MMT may explain why MMT is more popular in the U.S. than in other countries. The propositions of MMT may cause serious financial instability in an open economy with flexible exchange rates as fixed exchange rates would impose a hard budget restraint on the government which would mean that the government could default on its debt.

MMT and Economic Policy

At first glance, it seems that MMT and the almost worldwide monetary policy called quantitative easing (QE) have much in common. In MMT as with QE, the central bank creates very large quantities of money, mainly by buying government securities in the secondary market. The similarity ends there. QE is designed as a temporary policy in order to stabilize economies which suffer from financial crises, such as that caused by a pandemic virus. QE is not and was never intended to finance government expenditures (Globerman  2020 ). Central banks will start to reduce the quantity of money after the crises by selling back government securities before they mature (Globerman  2020 ). Although QE means a certain degree of monetizing government debt, it remains a policy instrument of a politically independent central bank (Epstein  2019 ).

In contrast, in MMT the government finances public expenditures via money creation, with no intention to refinance them with taxes (Bell  2000 ). That is, monetization of the debt is forever. In this way, politicians control the creation of money and not politically independent central banks. Moreover, monetary policy explicitly finances government expenditures. Monetary policy is no longer monetary policy, but rather a combination of monetary and fiscal policy (Tymoigne  2016 ). As is recognized by serious proponents of MMT (Mitchell  2010a , 2010b ), such a policy can only last as long as there are spare capacities in an economy in the form of unemployed workers and underused production facilities. If capacity is fully used, additional money will create inflation. At this point, the government should increase taxes to avoid inflation by restricting private resource use via consumption and investment. In contrast to QE, the creation of money (or, equivalently, the monetization of government debt) in MMT is an instrument to finance public expenditures. Taxes serve as instruments to reduce private consumption and investment, in order to avoid inflation. However, there are also new ideas to employ taxes for financing social policy and even a Green New Deal (Baker and Murphy, 2020 ).

The differences between QE and MMT demonstrate that MMT has different political intentions. Monetary policy is employed to finance the state in order to release taxation from its usual function of financing public goods. Another policy recommendation underlines this intention, the so-called job guarantee (JG) (Mosler  1998 ; Parguez  2008 ; Tcherneva  2020 ). JG “is at the centerpiece of MMT reasoning. It is neither an emergency policy nor a substitute for private employment, but would become a permanent complement to private sector employment” (Mitchell et al., 2019 , p. 295). JG is considered as an automatic stabilizer in MMT (Mitchell et al., 2019 , p. 303) and would be financed by money creation, i.e., public debt. Although it has some resemblance to Keynesian deficit-financed stabilization policies in a recession, guaranteeing jobs that produce goods and services at the minimum wage is outside the Keynesian concept. In effect, it is labor market policies paid for by money creation. However, that JG policy may become inflationary is denied (Mitchell et al., 2019 , p. 304) because the government is “buying labour off the bottom” (Mitchell et al., 2019 , p. 304), i.e., that minimum-wage JG-employment has no effect on the structure of wages. Moreover, MMT ignores all microeconomic problems of JG policy.

This brief look at the differences between QE and MMT demonstrates that the monetary concept of MMT has almost nothing in common with QE. The MMT policy intentions promise a kind of new brave world that is economically stable, socially more equal and environmentally green. However, the economics of MMT are unclear at best. Who will pay for this world remains an unanswered question. As MMT seems to suggest, it is a free lunch.

As a matter of fact, someone has to pay sometime for the economic, social and environmental benefits of MMT. Since taxes are excluded and public deficits are monetized, the inflation tax is financially the last resort, unless it is avoided by taxes. Hence, the usual result is still valid. The usage of real resources must be paid for, either through ordinary taxes, the inflation tax or financial repression.

This leads to the final point of the analysis as MMT neglects the political aspects of recommended policies. MMT hands over responsibility for fiscal and monetary policy to politicians seeking re-election, hoping that these politicians will act responsibly. Therefore, MMTs over-simplistic analysis understates the risks of the policy implications (Palley  2015b ). For policy recommendations, larger sets of behavior functions are required that show how households and firms react and adjust to such policies (Machlup  1963 ). Mankiw ( 1988 ), Reinhorn ( 1998 ) and Otaki ( 2007 ) incorporate imperfect competition into the Keynesian cross model. Therefore, one can say that the policy implications and recommendations of MMT are neither theoretically well-founded nor politically justified (for further critical reviews of MMT, see e.g. Brady  2020 ; Newman  2020 ; Skousen  2020 ).

The main contribution of this paper to the literature on MMT concerns the theoretical foundation of MMT. In a simple macroeconomic model, SIM, it is shown that MMT is indistinguishable from the Keynesian cross model, as well as neoclassical macroeconomic models. Demonstrating this with models is a necessary step to demystifying and debunking MMT as an economic theory.

There are few cases where many economists, Keynesian or Austrian, agree, but the rejection of MMT’s hypotheses is one of them (Brady  2020 ; Skousen  2020 ). In the current paper, simple macroeconomic models were applied to show that there is almost nothing new in MMT. The important insight is that the fundamental role of the so-called fiscal stance in MMT (i.e., equilibrium national income is equal to government expenditures divided by the tax rate on income, \({Y}^{*}=\frac{G}{t}\) ) is a relationship that holds trivially true in all Keynesian cross models and even in neoclassical macroeconomic models. It is neither specific to MMT nor does it follow from a new theory of money.

In fact, the fiscal stance is the consequence of the ex post identities of the economic circuit, an aggregate consumption function of private households and the non-Ponzi-game condition for the state. In the SIM model, the latter condition renders money meaningless because it is by definition an accounting identity, and because output used by the state can no longer be consumed (or saved) by private households. Ultimately, government expenditures are financed by taxes, whatever they are called. Moreover, it is not possible to say that the government can determine equilibrium national income. This statement is a misunderstanding of the fiscal stance that is an equilibrium condition, without any causality whatsoever.

Furthermore, MMT does not provide a theory of money. Instead, “money is a creation of the state” is the simple statement on which money is based (which is the topic of Knapp’s “The State Theory of Money”, published in German in 1905 ; MMT theorists quote this origin). However, in comparison to the conventional theory of money, this is a big step backwards. Last but not least, the far-reaching policy recommendations of MMT are not justified by economic theory. They are highly exaggerated since no further behavioral assumptions for households or firms are formulated that could show how the respective economic entities react and adjust to the recommended policies.

The Online Supplemental Appendix shows in a two-period variant of SIM that in MMT ex post Ricardian equivalence must hold true. The reason is that government expenditures use real economic resources that must be transferred from private households to the state. The instrument to carry out this transfer is called taxes.

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We thank an anonymous referee for very helpful comments and recommendations, including pointing out comparisons with Keynesian and neoclassical models. All errors are ours.

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Prinz, A.L., Beck, H. Modern Monetary Theory: A Solid Theoretical Foundation of Economic Policy?. Atl Econ J 49 , 173–186 (2021). https://doi.org/10.1007/s11293-021-09713-6

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Monetary policy is one of the two principal means (the other being fiscal policy) by which government authorities in a market economy regularly influence the pace and direction of overall economic activity, importantly including not only the level of aggregate output and employment but also the general rate at which prices rise or fall. Indeed, the predominant trend since the mid-twentieth century has been to place increasing emphasis on monetary policy (and correspondingly less on fiscal policy) for these purposes. Governments carry out monetary policy, typically via specialized agencies called central banks, by exploiting their control over the supply of certain kinds of claims against the central bank—hence the label ‘monetary’—that enable a country’s businesses, banks, and individuals to carry out their day-to-day economic affairs. In most financial systems, banks in particular are legally required to hold claims against the central bank in order to create deposits and make loans, and so the central bank’s control over the supply of claims against itself also gives it a form of control over the economy’s money and credit in a far broader sense. The evidence from experience, in one country after another, makes clear that the exercise of this control—‘monetary policy’—powerfully affects a country’s economy, for either good or ill.

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Get 10% off with fall23 discount code, 1. how monetary policy arises.

Providing money for use in everyday transactions has been a commonplace function of governments for well over 2,000 years. Today almost all paper currency is ‘fiat money’—in other words, it has value only because the government mandates that within the country’s borders it must be accepted as payment in any and all transactions. (Importantly, the government does not mandate, because in a market economy it cannot, the price level at which its currency is accepted.)

In principle, the existence of fiat currency alone would be sufficient to enable a government to carry out a primitive form of monetary policy, distributing paper money to the public, through some device or other, in either small volume or large as it saw fit. In fact, modern central banks conduct monetary policy differently: by exchanging claims against themselves for other claims against the government—typically interest-bearing bills, notes, and bonds—in markets in which these instruments are freely traded. For this exchange to be possible, however, there must be other claims against the government outstanding in the first place.

Hence, monetary policy, as carried out in practice, is made possible by the existence of fiscal policy, in the usual sense of overall government spending and taxing and the government’s need to finance any excess of expenditures over revenues by means of borrowing. It is only because on balance over time most governments have spent more than they have taken in—that is, have run a fiscal deficit—that they have a stock of debt obligations outstanding.

2. How Monetary Policy Works

The chief objectives of monetary policy in modern times typically have been to maintain stability of a country’s general price level—that is, to prevent either inflation or deflation—and to promote maximum levels of output and employment. Other often accepted goals of monetary policy include maintaining balance in a country’s international trade, preserving stability in its financial markets, and fostering increased capital investment so as to enhance its economic growth over time. With the exception of preserving financial market stability, which is usually taken to be secondary, all of these objectives pertain to aspects of an economy’s nonfinancial economic activity. By contrast, central banks’ monetary policy operations take place exclusively in the financial markets. For monetary policy to be effective therefore requires some process, often called the monetary policy ‘transmission mechanism,’ by which the purely financial actions taken by the central bank influence the nonfinancial decisions of households and firms.

2.1 Demand for Central Bank Liabilities

The key to how this mechanism works is that, in part for reasons of convenience and in part as a matter of law, participants in a country’s nonfinancial economy need to hold claims against its central bank—the outstanding total of which is usually called the country’s ‘monetary base.’

At the simplest level, currency is usually a claim on a country’s central bank. Individuals who buy everyday items for cash, and the businesses with which they deal, therefore need to hold and exchange central bank liabilities. In the past, sudden large increases in the public’s demand for currency, when not met by an increase in currency supplied by the central bank, often triggered financial crises and consequent economic downturns. In modern times, however, most central banks have passively supplied whatever changing volume of currency the public seeks. As a result, demand for currency typically plays no significant role in the monetary policy process.

Instead, what matters are the claims that the country’s private-sector banks hold in the form of deposits, usually called ‘reserves,’ at the central bank. For several reasons, the banks’ need for these reserves expands or contracts roughly in pace with the overall level of activity taking place in the nonfinancial economy.

First, in many countries banks must, by law, hold such reserves in proportion to the volume of deposits (or if not their total deposits, then some forms of deposits) that they have outstanding. Hence, the ability of the banking system to create deposits for businesses and households to use in executing transactions that they do not make in cash depends on the quantity of reserves that they can obtain.

Second, a bank’s ability to make loans depends on its ability to create deposits. A loan is an asset to the bank, while a deposit is the bank’s liability. Apart from changes in the bank’s capital due to retained profits or new securities issues, its total assets and total liabilities must expand or contract together. The requirement that banks hold reserves in proportion to their deposits, therefore, also means that they must hold reserves in order to advance credit to businesses or households.

Third, although some countries do not impose legal reserve requirements, their banks hold balances at the central bank to use for settling the claims among themselves that arise whenever an account holder at one bank deposits a check drawn on another bank. Even in some countries that do have reserve requirements, a large part of the balances that banks hold at the central bank are likewise held primarily for purposes of settling interbank claims. The standard way of effecting such transfers is to shift reserves, on the books of the central bank, from one bank to the other.

2.2 The Central Bank as Monopolist

The central bank’s power to conduct monetary policy stems from its role as the sole source of reserves (or, again, monetary base) to meet this demand. In short, the central bank is a monopolist over the supply of its own liabilities.

2.2.1 Open market operations.

The most common procedure by which central banks either increase or reduce the outstanding supply of bank reserves is through ‘open market operations’—that is, buying or selling securities (normally the debt obligations of the central bank’s own government) in the free market. When a central bank buys securities, it makes payment by increasing the reserve account of the seller’s bank. Doing so increases the total volume of reserves that the banking system collectively holds. No bank, nor any other market participant, can add to or take away from the total volume of reserves that all banks together hold.

Expanding or shrinking the total volume of reserves in this way matters because banks can trade reserves among one another in exchange for other assets. Because the central bank pays only a low rate of interest (often zero) on these balances, any bank that has more reserves than it needs typically will try to exchange them for some interest-bearing asset. If the banking system as a whole has excess reserves, however, more banks will seek to buy such instruments than to sell them, thereby bidding up these instruments’ price and thus reducing the interest rate on them. The resulting lower return on interest-bearing assets means a reduced opportunity cost of holding zero-interest reserves. Only when market interest rates fall to the level at which banks collectively are willing to hold all of the reserves that the central bank has supplied will the financial system reach an equilibrium.

Hence, an ‘expansionary’ open market operation (in which the central bank expands the supply of reserves) creates downward pressure on short-term interest rates not only because the central bank is itself a buyer in the securities market but, more importantly in quantitative terms, because it leads banks to become buyers of securities as well. Conversely, a ‘contractionary’ open market operation, in which the central bank sells securities, puts upward pressure on short-term interest rates. Under ordinary conditions, a well-functioning central bank following these procedures can pick some short-term interest rate (in many countries the central bank focuses on the overnight interbank lending rate) and establish that rate at whatever level it chooses.

2.2.2 Reserve requirements.

In a banking system that imposes reserve requirements, an alternative way for the central bank to achieve the same objective would be to adjust the stated percentage indicating how much in reserves banks are required to hold in relation to their outstanding deposits. Lowering the reserve requirement, and therefore reducing the demand for reserves, has roughly the same effect as an expansionary open market operation, which increases the supply of reserves: either action creates downward pressure on interest rates. Although in principle central banks could carry out monetary policy by either means, in practice most rely primarily on open market operations, using changes in reserve requirements only to achieve more technical objectives concerning the composition of banks’ liabilities.

2.2.3 Central bank lending.

Another way in which central banks can change the supply of reserves is by lending reserves directly to some bank. In most countries that have reserve requirements, such direct lending of reserves is normally small in scale, and it plays only a minor role in the monetary policy process. Especially in countries that impose no reserve requirements, however, lending directly to banks is an important part of how the central bank supplies reserves.

Because no bank will pay more to borrow elsewhere than the rate at which it can freely borrow from the central bank—and, similarly, will not sell a higheryielding asset rather than borrow at a lower rate in order to continue holding it—setting the interest rate at which the central bank lends reserves to the banks effectively establishes a ceiling for (risk-free) shortterm market rates. In some countries, the central bank confines the market rates on short-term instruments to trade within a narrow range by imposing both a ceiling and a floor: setting an interest rate at which it will lend to banks as well as a (slightly lower) interest rate that it will pay banks on their holdings of reserve balances.

2.3 Effects on the Nonfinancial Economy

For monetary policy to achieve its objectives with respect to the nonfinancial economy, there must be some causal process by which the changes that the central bank brings about in short-term interest rates in turn affect real output and employment, or prices and wages, or both. Economic theory, as well as empirical observation, suggests a variety of avenues by which such influences can operate.

2.3.1 Influences on the demand for goods and services.

In an economy with well-developed credit markets, households and firms frequently borrow to finance their spending. Fluctuations in interest rates naturally affect the willingness to undertake such expenditures. Although the central bank directly controls only the interest rates on short-term instruments like Treasury bills, the longer-term interest rates applicable to borrowing for these purposes mostly move in the same direction as short-term rates because banks and other investors are able to substitute among different debt instruments in their asset portfolios. Moreover, because banks’ ability to create credit depends on having reserves, by decreasing the supply of reserves the central bank can induce banks in particular to cut back on lending in ways that go beyond merely charging a higher interest rate, including rationing credit among would-be borrowers.

The same process of portfolio substitution also leads to downward pressure on the market prices of other assets, most prominently equity securities and real estate. Because these price-sensitive assets bulk large in the total holdings of households (and sometimes firms too) in many countries, changes in wealth also normally influence the demand for goods and services. Yet a further extension of the same process enables monetary policy to influence the value of a country’s currency in international markets, which in turn affects demand abroad for the country’s exports as well as demand at home for foreign imports.

2.3.2 Demand effects on prices, employment, and wages.

If a central bank’s monetary policy stimulates the demand for its economy’s goods and services, and there is no immediate matching change in supply, the result will be to create upward pressure on prices. Higher prices in turn lead businesses to seek to produce more. In industries that are labor intensive, increasing production means hiring more workers. Hence, monetary policy also influences employment. In order to attract more workers, however, firms normally have to pay higher wages. Hence, an increase in output and employment due to expansionary monetary policy usually means upward pressure on both prices and wages—in other words, inflation.

2.3.3 Price misperception effects on aggregate supply.

Under some economic theories, this tendency for output to increase and prices to rise following expansionary monetary policy has a different interpretation: what matters is that the increased prices due to greater aggregate demand come as a surprise. If a firm mistakenly interprets a rise in the general price level for a rise only in the price of its own specific product, it will, as before, choose to expand production. The immediate effect is the same, but once the firms that react in this way realize their mistake, their incentive to maintain higher production disappears. Under this theory, therefore, monetary policy can still influence both output and prices, but the effect on prices is lasting while that on output is only temporary.

2.3.4 Effects on prices and wages only.

Yet a further extension of this same line of theorizing suggests that if people understood that the effects of monetary policy on output and employment are merely temporary—and, importantly, if they also understood what the central bank is doing as it is doing it—there would be no real consequences of monetary policy at all but only the influence on prices and wages. Although constructs that deliver this conclusion appear frequently in theoretical work, evidence that monetary policy does have real effects is sufficiently widespread that current-day interest in this line of thought focuses less on whether monetary policy is ‘neutral’ in this sense than on the theoretical rationale for understanding why it is not.

3. The Design of Monetary Policy

Monetary policy is problematic not only because the central bank’s goals are sometimes in conflict but also because the mechanisms by which central bank actions affect the nonfinancial economy mostly involve lags often measured in years rather than weeks or months.

Many important aspects of the economic circumstances in which the central bank’s actions will be having their effect are, therefore, not just unknown but unknowable when the decisions governing these actions are taken. Much of the study of monetary policy since World War II has focused on how to conduct monetary policy under these handicaps.

3.1 The Monetary Policy Instrument

Because of its monopoly position, the central bank can fix the quantity of reserves (or, including currency, the monetary base). Doing so affects the market equilibrium of interest rates on all debt instruments. Alternatively, the central bank can set the interest rate on any one class of debt instrument by continuously supplying whatever amount of reserves is consistent with market equilibrium at the chosen interest rate level, allowing market forces to determine what quantity of reserves it supplies. The market equilibrium also determines the interest rates on all other debt instruments. (A variant of this latter strategy is for the central bank to set the foreign exchange rate of its currency.) By contrast, the central bank cannot directly set the volume of banks’ deposits or lending. Nor can the central bank directly determine real output, or prices, or any other aspect of nonfinancial economic activity.

If all other influences bearing on whatever constitutes the ultimate objective of monetary policy were known in advance, it would make no difference whether the central bank conducted policy by fixing the supply of reserves or by setting an interest rate (or the exchange rate). These operating strategies would be equivalent. Because many forces bearing on the central bank’s objectives are unpredictable, however, the choice of ‘instrument’ by which to implement policy matters for the effectiveness of policy. In general, the more uncertainty surrounds the behavior of households and firms in the markets for goods and services—for example, the strength of consumer spending, or of business investment—the more advantage there is to fixing the quantity of reserves. By contrast, the more uncertainty surrounds behavior in the financial markets—households’ and firms’ demands to hold deposits vs. other assets, their desire to borrow, the willingness of banks to lend, and so on—the more advantageous it is to set the price of reserves (in other words, an interest rate).

Actual practice in this regard has varied over time and across countries. Especially in the 1970s and 1980s, many central banks experimented with strategies based on fixing the quantity of reserves (or of the monetary base), or its growth rate. As of the beginning of the twenty-first century, however, most central banks of large countries operate by setting an interest rate.

3.2 Intermediate Targets

The central bank cannot directly set the amount of either money, in the usual sense that includes both currency and bank deposits, or bank credit. Much empirical work over many years, however, has gone into documenting the relationships between money and either income or prices—especially between money and future income or prices—and there has been some research on comparable relationships for credit. Moreover, data reporting in most countries is such that money and credit are observed before output and prices. To the extent that money, for example, displays a reliable relationship with the aspects of nonfinancial economic activity that the central bank ultimately seeks to influence, conducting monetary policy as if the quantity of money itself, or its growth rate, were the objective of policy—that is, using money as an ‘intermediate target’—in effect enables policy to respond to unwanted movements in output or prices before they occur (or at least before they are directly observed). Especially in the 1970s and 1980s, many central banks adopted intermediate targets of this kind.

In time, however, this way of conducting monetary policy fell out of favor for several reasons. First, research showed that using money as an intermediate target amounts to a way of exploiting the information contained in observed movements of money, but that it fails to make use of other information provided by the many different financial and economic variables that are also observable on a timely basis. Further, except under highly special circumstances, using money as an intermediate target fails to use efficiently even the information provided by observations of money itself.

Second, there was never a sound theoretical basis for knowing which measure of money was the right one to target, and even within any one country empirical evidence on which measure had the closest relationship to income and prices was often mixed. Presumptions that different measures of money would show roughly similar growth rates over relevant time horizons proved mistaken.

Third, and most importantly, by the 1990s the empirical relationships between money (or credit) and either income and prices had broken down in many countries. Standard explanations for this breakdown included financial innovations that enabled money holders to switch more easily among different kinds of deposits, or between deposits and other assets; new patterns of wealth holding in the wake of the high inflation of the 1970s and early 1980s; and the advancing integration of world financial markets. But for whatever reason, the previously observed predictive power associated with money disappeared, and without it there was little rationale left for using any measure of money as an intermediate target for monetary policy.

3.3 Rules vs. Discretion

One reason the use of money as an intermediate target had been so attractive was that it supposedly provided an ‘anchor’ to a country’s price level—or, if the central bank was targeting money growth, to the inflation rate. (Once the empirical relationship between money and prices broke down, this supposition bore much less force.) A second reason was that money could potentially serve as the basis for very simple rules for conducting monetary policy. For example, always seeking to have money grow at a constant percentage rate (which some economists have advocated) may be suboptimal, but it is not inherently flawed on theoretical grounds. By contrast, always setting some interest rate at a constant value is inherently unstable. The long-standing preference among some economists for rules to govern monetary policy reflects, in the first instance, matters less of economics than of political economy. But in the 1970s and 1980s a new line of theory suggested a more specifically economic ground for favoring rules for monetary policy: that the sequential, discretionary decisions made even by fully knowledgeable and well-intentioned central banks were ‘dynamically inconsistent’ in a way that accounted for the chronic high inflation that by then had appeared throughout the industrialized world. Central banks understandably seek to boost output and employment above the level that market forces would otherwise establish, and under some theories a way to do so is to generate inflation that comes as a surprise to producing firms. But once the central bank has already generated any particular rate of inflation, which is then expected to continue, a yet higher rate is necessary to create the needed surprise. This process goes on until the inflation rate is so high that the cost of any further increases in inflation per se outweighs the consequent gain in output. At that point output reverts to its normal level, but inflation remains high. Because the dynamic inconsistency argument placed discretionary decision making at the center of the industrial countries’ inflation problem, this line of theory pointed to a monetary policy rule as the most straightforward solution. Judged from this perspective, the disinflation that followed was, in most countries, strong counter-evidence. By the early 1990s (earlier still in many countries), inflation had fallen sharply in most industrialized economies. In many this disinflation occurred without any change in central bank procedures, and certainly without the adoption of a monetary policy rule. Even in countries that did change their approach to monetary policy—for example, by adopting an explicit inflation target—the change typically came after inflation had already subsided.

A policy rule is not the only way to overcome dynamic inconsistency, however. Further research showed that the central bank’s awareness of the importance of its public reputation (‘credibility’) acts in the same way. So does appointing central bank decision-makers whose aversion to inflation is more pronounced than that of the general public. Hence, it remains unclear to what extent theories based on dynamic inconsistency provide a good account of the rise and fall of postwar inflation.

3.4 Central Bank Independence

The debate over rules vs. discretion in monetary policy also focused attention on the differing status of different countries’ central banks: whether the central bank has the authority to establish the objectives of monetary policy and or to carry out policy operations as it sees fit in pursuit of objectives even if they may be determined by other parts of the government, whether the central bank’s officials are subject to removal over matters of policy, and so on. Countries where the central bank was more independent, either legally or de facto, tended on average to have lower inflation. Some economists inferred from this tendency that the motivation to seek higher output and employment by creating surprise inflation was mostly imposed on the central bank from outside. Hence, a more independent central bank would deliver lower inflation. (At the same time, however, other research pointed out that a key corollary of this line of reasoning—the implied tendency for more independent central banks to find it less costly, in terms of foregone output and employment, to reduce inflation by any given amount—did not correspond to observed crosscountry differences.)

One result of this line of research and public discussion was that in the late 1990s several countries formally granted their respective central banks greater independence. Also, the new European Central Bank, established in 1999, has very substantial independence from the governments of the participating member countries.

3.5 Inflation Targeting

By the 1990s the combination of the demise of intermediate targets for monetary policy, the renewed emphasis on interest rate setting, and the failure (by some lights) to impose rules limiting central bank discretion had left a widely perceived vacuum in the structure of most countries’ monetary policymaking. The problem of providing an ‘anchor’ to prices remained. So did the risks associated with step-by-step discretion.

In response, a number of central banks adopted formal ‘inflation targets.’ Importantly, adopting an inflation target does not necessarily mean eschewing concern for real economic outcomes, nor does it imply the belief that money is neutral in the short or medium run. When a central bank seeks to maintain both low inflation and full-employment output, the relative strength of its preferences between these two objectives determines how rapidly it will seek to return to the targeted inflation rate after some departure has occurred.

One hoped-for advantage of having an explicit inflation target is to facilitate public monitoring and evaluation of the central bank’s performance. The underlying presumption is that, on average over time, the central bank can achieve whatever inflation rate it seeks. Hence, failure to satisfy the stated target can be laid at the central bank’s door.

4. Outstanding Research Questions

It would be wrong to give the impression that by the end of the twentieth century the combination of experience and research had settled all important questions about monetary policy. Monetary economics is not a laboratory science with the ability to conduct controlled experiments. Moreover, many questions that bear centrally on how best to conduct monetary policy hinge on how an economy’s businesses, households, and banks behave in contexts where the changing economic backdrop and changing institutional arrangements matter importantly. Even if such questions appear settled at some time, therefore, the answers do not necessarily remain valid.

4.1 The Transmission Mechanism

A perennial goal of the monetary policy research agenda is to understand the behavioral process by which the central bank’s actions influence the nonfinancial economy. In theory, there are many potential influences at work. But especially for purposes of actual policy implementation, knowing how much of the overall effect of policy is due to each is important. One particular focus of theoretical and empirical research in this area, for example, centers on the distinction between the ‘money view,’ according to which contractionary monetary policy works by restricting the amount of deposits that banks can create (thereby driving interest rates higher, and thus depressing demand for goods and services), and the ‘credit view,’ under which what matters is instead banks’ reduced capacity to extend loans to firms and households seeking to finance expenditures.

Part of what makes this research program difficult is the tension between the preference for simple theories and the need to take account of the often quite involved circumstances under which banks, businesses and households interact. Extremely simple theories of monetary policy often deliver conclusions that may be appealing intellectually but that observed experience readily contradicts—for example, that monetary policy affects prices but not real economic activity, or that inflation varies in close proportion to money growth. Theories leading to conclusions more in line with experience tend to be complicated, and the need to draw more finely focused inferences thwarts easy empirical validation.

4.2 Quantitative Measurement

For a central bank charged with carrying out a country’s monetary policy, even full knowledge of the qualitative process by which policy works is not sufficient. It is also necessary to have some idea of how much to increase or reduce the supply of reserves, or how far to raise or lower interest rates, in order to achieve any given objective at any particular time. Such knowledge can be no more than a statistical estimate, subject to uncertainty. But having such estimates, and also an informed sense of the associated uncertainty, is crucial.

In recent decades three lines of empirical research have represented attempts to gain such knowledge. Structural economic models—models that use theory to place restrictions on the admissible representation of the behavior under study—allow the use of observed data to measure specific parts of the monetary policy process, and putting together enough such parts produces a quantitative representation of the monetary policy process as a whole. Here theory matters: the value of the resulting estimates, for either the parts or the whole, depends on the validity of the a priori restrictions imposed. Most central banks estimate and regularly use structural models of this form, although little such work has taken place in the academic world in recent years.

Especially since the 1970s, vector autoregressions (sets of equations that intensively exploit the raw covariation over time of a small number of economic variables) have been the main vehicle used in academic research for addressing questions about monetary policy at the aggregative level. When used for purposes like assessing the effects of monetary policy, however, even vector autoregressions are not free from restrictions based ultimately on theory—most basically, what (usually small) set of variables to include, and what ‘causal ordering’ to impose on them. Still richer sets of cross-equation restrictions allow ‘structural vector autoregressions’ to exploit the covariation in the data yet more fully. As is true for structural models, the resulting estimates depend on the validity of the restrictions imposed.

Beginning in the late 1980s, there has also been renewed interest in combining standard statistical methods with the use of nonquantitative information—drawn, for example, from close reading of minutes of central bank meetings. To date this work has been carried out for only a few countries.

4.3 Phillips Curve Issues

The trade-off between the desire for price stability and the desire for high output and employment has been a persistently important aspect of monetary policy debate, and consequently of monetary policy research, throughout the postwar era. One crucial question is what level of real activity is consistent with maintaining an unchanged inflation rate. Another is how much foregone output or employment is required to bring a high inflation rate down to a lower one (what is the ‘sacrifice ratio’?). Although some theories imply that monetary policy is neutral, most experience indicates that there are real costs to disinflation. The question that much research has tried to answer from observed evidence is how much.

Neither the noninflationary level of output (or employment) nor the sacrifice ratio is a natural constant, however. An important part of this same line of research has been to establish what factors, especially including factors subject to influence by national policies, cause each to vary across countries. Possible determinants suggested by familiar theory include labor market institutions governing the difficulty of hiring or firing workers, the generosity of publicly provided unemployment benefits, the economy’s openness to international trade, the degree of central bank independence, the central bank’s established ‘credibility,’ and the extent to which monetary policy decisions are transparent to the public. Research on each of these topics has provided mixed results.

Each of these lines of inquiry is implicitly a question about the short, or at most the medium, run. Implicit in the underlying theory is that in the long run output and employment revert to levels determined by resources, technologies, preferences, and other fundamental factors that are independent of monetary policy. Even so, there remains a long-run trade-off between the variability of output and employment and the variability of inflation, which the central bank’s approach to monetary policymaking does influence. Seeking to understand how this variability trade-off arises, and exploring the implications for it of different ways of conducting monetary policy, remains an important object of research.

A quite different line of research on these issues, prompted in part by the chronic high unemployment and stagnant growth in so many European countries in the last quarter of the twentieth century, has questioned the standard theory that monetary policy is neutral in the long run, so that a reduction in inflation requires only a temporary loss of output and employment. If the economy’s production process adjusts so that some part of the reduced output or employment never recovers (e.g., because some unemployed workers leave the labor force permanently, or because some productive investments are not undertaken), then the usual interpretation of the sacrifice ratio in terms of strictly temporary real costs of achieving permanent disinflation is invalid.

4.4 Costs of Inflation

Much of the motivation underlying the conduct of monetary policy is to preserve price stability, or at least a low rate of inflation. For some central banks, price stability is the only economic objective formally stated in the bank’s charter. For others price stability is one among just a few objectives set forth.

By contrast, economic theory and empirical analysis have never been able to identify just why movements in an economy’s overall price level are so harmful. In the simplest theories, inflation that is anticipated in advance has no real effects at all, and unanticipated inflation merely creates transfers from some groups to others. Abandoning simplicity in favor of realism introduces many avenues for inflation to result in welfare-reducing costs, but empirical estimates of the magnitude of such costs are typically small. There is also no evidence that inflation below about 10 percent per annum reduces an economy’s growth rate.

Yet opinion surveys as well as election returns give evidence that the public in most countries dislikes inflation, and even accepts sizeable real costs as a sacrifice necessary to reduce inflation. One possibility is that the aspect of inflation that most distresses the public is not economic, in any narrow sense, but instead the concern that if the government is not able to carry out this aspect of its responsibilities effectively—providing a medium of exchange has been a government function almost as long as there have been governments—then perhaps the social order may be at risk in other ways as well. In any case, although understanding the costs of inflation has long been on the research agenda surrounding monetary policy, it remains an even more open question than most.

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research paper on monetary economics

Shifting Electric Vehicle Owners to Off-Peak Charging

This figure is a two-panel line graph titled, Effect of Incentives of EV Charging Behavior. The following pertains to the left-side panel. The y-axis is labeled, normalized share of kWhs charged off-peak. It ranges from 0.9 to 1.4, increasing by 0.1. The x-axis represents month and ranges from February to August. There is a vertical dotted line at April labeled, Phase 1.  There are three lines labeled on the graph: Nudge, Rewards, and Control. The Nudge line starts at above 1 in February but slowly decrease to about 0.95 by August. The Rewards line starts at near 1 in February before dipping below 1 in between March and April. To the right of the vertical dotted line labeled Phase 1, the Rewards line experiences a steep increase to over 1.3 by May before experiencing fluctuations and then dropping down to about 1.2 by the end of the period. The Control line starts at near 1 in February and experiences a slight increase to about 1.05 by July.  The following pertains to the right-side panel. The y-axis is labeled, normalized share of kWhs charged off-peak. It ranges from 0.9 to 1.4, increasing by 0.1.  The x-axis represents month and ranges from April to December. There are two vertical dotted lines. One at April labeled, Phase 1, and another at September labeled, Phase 2.  There are three lines labeled on the graph: Rewards (continue), Rewards (stop), and Control. The Rewards continue line starts at near 1.3 in April. It initially increases before dropping to 1.2 in September. After September, it increases to about 1.25 and levels off. The Rewards stop line starts at 1.2 in April and fluctuates between 1.2 and 1.3 until Phase 2 in September. After September, the line steeply declines to about 1 in December. The control line fluctuates between 1 and 1.1 for whole period. The follow pertains to both panels. Shaded areas represent 95% confidence intervals. Off-peak hours are 10 PM–6 AM. Nudge group received information on the benefits of shifting EV charging to off-peak hours. Rewards group received same information

Electric vehicle (EV) sales have been rising as a share of new car purchases, and they are expected to continue to do so because a range of public policies support the decarbonization of the transportation sector. The electricity used to charge an EV can be substantial. An average household consumes approximately 1 kilowatt-hours of electricity per hour. An EV charging on a common (level 2) fast charger typically uses 7 to 8 kWh per hour. The impact of greater EV penetration on the cost of electricity and reliability of electricity distribution systems will depend critically on when EVs are charged, as charging during high-demand times could strain the system and necessitate substantial investments in grid infrastructure. Encouraging EV drivers who might charge at high-demand times to shift to other times when there is surplus grid capacity can significantly reduce the cost of EV integration. In Show Me the Money! Incentives and Nudges to Shift Electric Vehicle Charge Timing (NBER Working Paper 31630), Megan R. Bailey , David P. Brown , Blake C. Shaffer , and Frank A. Wolak use a field experiment to measure the relative effectiveness of financial rewards and behavioral nudges in shifting EV charging to off-peak times.

Households in Calgary, Alberta were recruited from a municipally owned electricity distribution utility. They were randomized into one of three groups: a rewards group that received a financial incentive of 3.5 cents Canadian per kilowatt-hour, roughly a 23 percent discount from their hourly electricity rate, for charging during the off-peak hours from 10 pm to 6 am; a nudge group that received information from the company on the societal benefits of charging in off-peak hours; and a control group that received no intervention. The hourly electricity consumption of all three groups was monitored during the experiment. Financial incentives were effective at shifting EV charging behavior, with the households receiving the off-peak discount collectively shifting their average share of kWh charged during off-peak hours from 59 to 77 percent. The nudge group showed no change in charging behavior and was statistically indistinguishable from the control group. To test for habit formation, a randomly selected half of the rewards group was told they would no longer receive financial incentives for off-peak charging while the other half continued to receive the off-peak discounts. The charging behavior of the group that no longer received the subsidy reverted to its pre-intervention pattern. Continued financial incentives were needed to maintain the shifts in charging-time behavior. The researchers conclude that EV charging behavior is more price-responsive than many other forms of residential electricity use, perhaps because shifting charging times does not sacrifice driving capability. This contrasts with the effect of timing shifts in the use of many residential appliances, such as air conditioners, the use of which must coincide with the electricity draw.

— Susan Stewart

The researchers are grateful to their partner utility, ENMAX Power, for sponsoring and managing this field experiment.

Also in this issue:

  • Exploitation of Prison Labor in Colonial Nigeria
  • Cash Transfers and Child Welfare: Lessons from Alaska
  • Occupational Choice in the Face of Technological Disruption
  • Algorithms, Judicial Discretion, and Pretrial Decisions
  • The Role of ‘Green’ Investors in Reducing Corporate Carbon Emissions

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  1. JME

    The Journal of Monetary Economics publishes important research contributions to a wide range of modern macroeconomic topics including work along empirical, methodological and theoretical lines. In recent years, these topics have been: asset pricing; banking, credit and financial markets; … View full aims & scope $3830 Article publishing charge

  2. Journal of Monetary Economics

    The Journal of Monetary Economics was founded in 1975, and quickly established itself as the leading professional journal in macroeconomics. It is consistently ranked as one of the top journals in economics, and it is widely read by macroeconomists, financial economists, central bankers, and many others. ... Best Paper Award 2023 Winner ...

  3. 21638 PDFs

    Oct 2022 Jingqi Liang Oct 2022 Melahat Batu Ağirkaya Joseph Bitar Jul 2022 Atilla Ünlü Monetary economics provides a framework for analyzing money in its functions as a medium of exchange, store...

  4. Program Report: Monetary Economics, 2021

    Program Report: Monetary Economics, 2021 Emi Nakamura & Jón Steinsson For much of the last decade, policymakers in advanced economies have grappled with challenges resulting from the Great Recession of 2007-09 and sovereign debt problems in Europe.

  5. (PDF) FINANCIAL MARKETS AND MONETARY POLICY: A REVIEW OF ...

    The study surveys monetary policy and financial market research in developing countries and emerging economies over an eight year period. To do this, the Journal of Economic Literature (JEL)...

  6. Monetary policy and financial economic growth

    Volume 22, November 2020, e00169 Monetary policy and financial economic growth Reza Moosavi Mohseni , Jiling Cao Add to Mendeley https://doi.org/10.1016/j.jeca.2020.e00169 Get rights and content • This paper adds the bond market as the third asset in the growth model under the variation of parameters. •

  7. Monetary Policy Operations: Theory, Evidence, and Tools for

    Research Working Papers Monetary Policy Operations: Theory,… Monetary Policy Operations: Theory, Evidence, and Tools for Quantitative Analysis Ricardo Lagos & Gastón Navarro Working Paper 31370 DOI 10.3386/w31370 Issue Date June 2023 Revision Date November 2023

  8. Most Cited Articles

    The most cited articles from Journal of Monetary Economics published since 2020, extracted from Scopus. The economic effects of trade policy uncertainty. Dario Caldara, Matteo Iacoviello and 3 more January 2020 Volume 109, Pages 38-59. Monetary policy uncertainty. Lucas Husted, John Rogers, Bo Sun November 2020 Volume 115, Pages 20-36

  9. Role of monetary policy in economic growth and development: from theory

    Role of monetary policy in economic growth and development: from theory to empirical evidence Muhammad Ayub Mehar Asian Journal of Economics and Banking ISSN: 2615-9821 Article publication date: 11 May 2022 Issue publication date: 24 March 2023 Downloads 19240 pdf (299 KB) 2. Theoretical background and review of literature 3.

  10. Lifetime Memories of Inflation: Evidence from Surveys and the Lab

    Lifetime Memories of Inflation: Evidence from Surveys and the Lab. Isabelle Salle, Yuriy Gorodnichenko & Olivier Coibion. Working Paper 31996. DOI 10.3386/w31996. Issue Date December 2023. We study how individuals' memories of inflation shape their expectations about future inflation using both surveys and laboratory experiments.

  11. Monetary Policy, Inflation, and Crises: Evidence From History and

    Date Written: June 6, 2023 Abstract We show that a U-shaped monetary rate path increases banking crisis risk, via credit and asset price cycles, analyzing 17 countries over 150 years.

  12. PDF NBER WORKING PAPER SERIES

    workshop on empirical monetary economics and LSE for very useful comments and suggestions. We also thank Diego Kaenzig and Ezgi Kurt for excellent research assistance. The views in this paper are those of the authors and do not necessarily reflect the views of the Bank of Spain, the Euro-system or the Bank of England.

  13. Modern Monetary Theory: A Solid Theoretical Foundation of Economic

    This paper shows that so-called modern monetary theory (MMT) lacks a sound economic foundation for its far-reaching policy recommendations. This paper's main contribution to the literature concerns the theoretical foundation of MMT.

  14. Full article: How raising interest rates can cause inflation and

    The exchange rate response to an interest rate change is an important transmission channel for monetary policy, in addition to the fact that the exchange rate is probably the most important price in any economy, since it affects all other prices; see, e.g., Frieden (Citation 2016).The exchange rate is influenced by many factors, including short-term interest rates, which is the topic of this ...

  15. Federal Reserve Structure and the Production of Monetary Policy Ideas

    Michael D. Bordo & Edward S. Prescott Working Paper 31915 DOI 10.3386/w31915 Issue Date November 2023 We evaluate the decentralized structure of the Federal Reserve System as a mechanism for generating and processing new ideas on monetary policy over the 1960 - 2000 period.

  16. Financial Integration and Monetary Policy Coordination

    DOI 10.3386/w32009. Issue Date December 2023. Financial integration generates macroeconomic spillovers that may require international monetary policy coordination. We show that individual central banks may set nominal interest rates too low or too high relative to the cooperative outcome. We identify three sufficient statistics that determine ...

  17. Journal of Macroeconomics

    Since its inception in 1979, the Journal of Macroeconomics has published theoretical and empirical articles that span the entire range of macroeconomics and monetary economics. More specifically, the editors encourage the submission of high quality papers that are concerned with the theoretical or …. View full aims & scope.

  18. Full article: Output Effects of Monetary Policy in Emerging and

    Using 45 studies conducted between 2001 and 2014, this paper employs a meta-regression analysis (MRA) to synthesize vector-autoregressive findings of output effects of a tightening in monetary policy in 32 emerging and developing countries. The outcomes indicate a publication bias.

  19. Monetary Economics

    The Monetary Economics Program studies the conduct and effects of monetary policy, including its impact on interest rates and inflation, and the consequences of policy actions by central banks. It also considers macroeconomic forces that impinge on central bank decision-making.

  20. (PDF) Topics in monetary economics

    PDF | On Jan 1, 2014, Selien De Schryder published Topics in monetary economics | Find, read and cite all the research you need on ResearchGate

  21. Collected Papers on Monetary Theory on JSTOR

    One of the outstanding monetary theorists of the past 100 years, Lucas revolutionized our understanding of how money interacts with the real economy of producti... Front Matter ... Supply-Side Economics:: An Analytical Review Download; XML; Review of Milton Friedman and Anna J. Schwartz, A Monetary History of the United States, 1867-1960

  22. Monetary Policy & Economic Research

    Series Research Department Working Papers Papers presenting empirical and/or theoretical research by Boston Fed economists on topics in macro and monetary economics, finance, public policy, and other fields Featured Series

  23. Topics

    Home Research All Topics Topics All NBER research is categorized into topic areas that collectively span the field of economics. Featured Topics COVID-19 Included in this topic Childcare Challenges and Pandemic-Related Employment Dynamics Concentration and Resilience in the U.S. Meat Supply Chains Is Online Education Working?

  24. Asset Demand of U.S. Households

    Asset Demand of U.S. Households. Xavier Gabaix, Ralph S. J. Koijen, Federico Mainardi, Sangmin Oh & Motohiro Yogo. Working Paper 32001. DOI 10.3386/w32001. Issue Date December 2023. We use novel monthly security-level data on U.S. household portfolio holdings, flows, and returns to analyze asset demand across an extensive range of asset classes ...

  25. Monetary Policy Research Paper

    2.3.2 Demand effects on prices, employment, and wages. If a central bank's monetary policy stimulates the demand for its economy's goods and services, and there is no immediate matching change in supply, the result will be to create upward pressure on prices. Higher prices in turn lead businesses to seek to produce more.

  26. 2024 market and economic outlook

    We currently forecast U.S. economic growth to downshift materially in 2024. However, we believe a slower pace would be a healthy outcome for an economy that in 2023 was still experiencing repercussions from the global pandemic, and the fiscal and monetary policy responses that followed. Inflation will likely return to normal.

  27. Cash Transfers and Child Welfare: Lessons from Alaska

    The Alaska Permanent Fund Dividend (PFD) is a universal basic income program that has provided annual cash payments to all Alaska residents since 1982. Unlike many other transfer programs, such as the Earned Income Tax Credit, the PFD is not conditioned on income or employment status. Payment amounts fluctuate annually and average around $1,600 ...

  28. Algorithms, Judicial Discretion, and Pretrial Decisions

    In a new study of pretrial release decisions by judges, Algorithmic Recommendations and Human Discretion (NBER Working Paper 31747), researchers Victoria Angelova , Will S. Dobbie, and Crystal S. Yang find a small fraction of judges outperform the algorithm, while most do not. The researchers analyze data on pretrial decisions made by judges in ...

  29. Shifting Electric Vehicle Owners to Off-Peak Charging

    The hourly electricity consumption of all three groups was monitored during the experiment. Financial incentives were effective at shifting EV charging behavior, with the households receiving the off-peak discount collectively shifting their average share of kWh charged during off-peak hours from 59 to 77 percent.