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Buffer stock theories have been popularized as a potential explanation of a major empirical puzzle: the weakness and instability of the empirical relationship between money and the presumed arguments of money demand. In money regressions, particularly broad money regressions, the hypothesis that the coefficient of the lagged dependent variable is unity often could not be rejected. The estimation of the long-run demand function is accordingly questionable. In other words, econometric results can suggest that money holders face enormous adjustment costs, approaching infinity, in closing the gap between actual and desired money holdings.Continue reading

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Levi (1980) has suggested three channels through which money supply affects corporate profits: the wage lag channel, the inventory valuation channel and the debtor/creditor channel. Additionally a fourth channel is envisioned wherein an increase in money results in higher output and therefore higher profits. Each of these is discussed below.Continue reading

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Showing a man engaging in barter: offering chickens in exchange for his yearly newspaper subscription

Showing a man engaging in barter: offering chickens in exchange for his yearly newspaper subscription

Webley et al. (1983) conducted an interesting study of gift giving which ought to prove challenging to economists. Unfortunately they conclude with remarks about money which misrepresent the thinking of economists. It seems worthwhile to attempt to clarify this as the remarks are repeated in the text by Furnham and Lewis (1986) without further explanation or justification. The matter in question is the conclusion by Webley et al. (1983: 237) that ‘ . . . money does not meet the economists’ position of being a universal medium of exchange’.Continue reading

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Interest in the weekly money supply announcement of the Board of Governors of the US Federal Reserve system has increased since the Fed began targeting money supply growth in October 1979. Numerous authors have documented the behavior of US asset prices at the time of M1 releases: unexpectedly high M1 growth is associated with declines in US stock and Treasury bond prices and increases in US short-term interest rates and the value of the US dollar; the converse is true for M1 shocks in the opposite direction. The effect of US money surprises is also felt outside the USA. Several authors have examined the effect of US M 1 surprises on foreign asset prices, finding a significant effect for some markets. Cornell (1983) offers several theories of the effect of M1 releases on asset prices. If unexpectedly high money growth leads to an increase in expected inflation, the value of the dollar and dollar-denominated bonds declines.Continue reading

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Room rates and nominal profits have been strongly related to inflation, whereas occupancy rates and real profits have been independent of inflation

Room rates and nominal profits have been strongly related to inflation, whereas occupancy rates and real profits have been independent of inflation

There is no doubt that inflation has become a major concern for investors and consumers alike. However, the impact of inflation upon a specific industry or an individual firm is not intuitively obvious. While some industries might suffer from continuous inflation (in terms of decline in sales, lower capacity utilization, and reduced profitability), others might benefit or be virtually unaffected.

The tourism sector, in general, and the hotel industry as a significant subset of this sector, are particularly interesting cases for a micro analysis of the relationship between inflation and business performance. First, given the comparatively high component of fixed costs in hotel operations (Laventhoi Horwath 1977) and in most other sub-industry groups in the tourism sector (e.g. airlines) profitability is strongly related to levels of capacity utilization. Other things being equal, profitability in this sector, more than in other less capital intensive industries, is expected to be affected by inflation if entrepreneurs are not successful in adjusting capacities to changes in demand caused by inflation.Continue reading

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An important and neglected aspect of the interpretation of the inside money time series is the equilibrium relationship between inside and outside money. Reserve requirements, excess reserve holdings, the relative demand for currency, demand deposits, and time deposits all help determine the “money multiplier.” Any theory relying on inside-money endogeneity ought to specify the source of fluctuations in the money multiplier.

An important and neglected aspect of the interpretation of the inside money time series is the equilibrium relationship between inside and outside money. Reserve requirements, excess reserve holdings, the relative demand for currency, demand deposits, and time deposits all help determine the “money multiplier.” Any theory relying on inside-money endogeneity ought to specify the source of fluctuations in the money multiplier.

In postwar U.S. time series data, innovations in money have been associated with subsequent movements in real output (Sims 1980a; Stock and Watson 1987), and a substantial portion of this association is with innovations in “inside” money (roughly, bank deposits) (King 1984; King and Plosser 1984; Bernanke 1986; Boschen and Mills 1988). If inside rather than outside money is responsible for the empirical relation between money and output, how should this be interpreted? One recent interpretation is that this relation represents a “real business cycle” in which the arrival of information concerning future real disturbances induces foreshadowing movements in inside money. (See King and Plosser 1984; Freeman 1986; Freeman and Huffman 1986; and Boschen and Mills 1988.)Continue reading

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In recent years, interest in the inflationary repercussions of government deficit financing has increased. The impact of government debt (growth) on the money supply has been investigated extensively for the United States. The existing evidence is rather mixed. Not so long ago, little similar research for other industrialized countries existed, but recently a number of studies have examined the relationship between government debt and money growth in other industrialized countries. Most of these studies conclude that there is little evidence that government debt influences money growth in these countries. It is sometimes argued that in industrialized countries debt monetization is not an automatic process, whereas in developing countries deficits may be inflationary.Continue reading

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Figure 1. International prices and world money - 1900-83 (1938 = 100)

Figure 1. International prices and world money – 1900-83 (1938 = 100)

With the help of a newly constructed index of primary commodity prices (GYCPI) and two revised indices of manufactured product prices (MUV and USMPI), we have recently analyzed the trends in the relative prices of primary commodities from 1900 to 1986 (Grilli and Yang, 1988). But, while the trends in the terms of trade of primary commodities were previously the subject of much attention, there is still no systematic analysis of the movements of nominal commodity prices in the long term and of the relationships between these prices and the monetary and real conditions prevailing in the world economy in the current century. This is somewhat surprising, since primary commodities have long been internationally traded goods par excellence and their dominance of world trade has only relatively recently been challenged by manufactured products (Grilli, 1982).Continue reading

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Targeting interest rate vs. targeting the money supply

Targeting interest rate vs. targeting the money supply.
An increase in the price level or in real GDR,
with velocity stable, shifts rightwardthe money
demand curve from Dm to D’m.
If the Federal Reserve holds the money supply
at Sm., the interest rate rises from i (at point e)
to i’ (at point e’).
Alternatively, the Fed could hold the interest rate
constant by increasing the supply of money to S’m.
The Fed may choose any point along the money
demand curve D’m.

The buffer stock theory of money demand assumes that unforeseen changes in the money supply are initially absorbed in holdings of money balances, and over time are used to purchase a wide spectrum of assets and goods as real balance effects are set into motion. One popular empirical counterpart to the buffer stock approach-the shock absorber model developed by Carr and Darby (1981) – includes the unanticipated component of the money supply as an additional explanatory variable in the partial adjustment money demand model.

Incorporation of such a money shock variable is meant to address several troublesome attributes associated with the partial adjustment specification. First, empirical estimates of the partial adjustment model have often yielded highly inaccurate predictions of real money balances. Omission of a money shock variable as are regressor when the buffer stock specification is the “true” model of money demand would result in biased estimates of coefficients on the included explanatory variables, to the extent that these included variables are not orthogonal to the omitted variable. This specification bias may be one reason why estimates based on the partial adjustment model have exhibited parameter instability (Swamy and Tavlas, 1989b).Continue reading

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The standard Keynesian approach to macroeconomics holds that an increase in the money stock leads to a decline of short-term real interest rates (liquidity effect). An alternative view, associated with Friedman (1968) holds that increases in money supply mainly increase inflationary expectations which, through the Fisher effect, are incorporated into higher nominal interest rates. The issue is still unresolved because as Cornell (1983b, p. 644) points out: ‘The problem is that money, prices and interest rates, as well as Federal Reserve Policy are all endogenous. As a result, empirical tests of the relations among these variables are ambiguous without a structural model. Unfortunately, there is not yet a consensus on the appropriate structural model’.Continue reading