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Controversies in Monetary Economics

Revised Edition

John Smithin

This influential volume, which has been revised and updated for the twenty-first century, includes both new material and more detailed expositions of existing arguments. Although so-called ‘real’ theories of business cycles and growth are prevalent in contemporary mainstream economics, Controversies in Monetary Economics suggests that those economists who have instinctively focused on monetary factors in explaining macroeconomic behaviour are more genuinely ‘realistic’. The author combines an explanation of past and present monetary controversy with practical proposals for the conduct of monetary policy in the contemporary global economy. Several alternative approaches are discussed, ranging from the traditional quantity theory to post Keynesian theories of endogenous money.
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Chapter 7: An Alternative Monetary Model of Inflation and Economic Growth

John Smithin


7. An alternative monetary model of inflation and economic growth INTRODUCTION This chapter presents a model which combines features of what Keynes (1933) called a ‘monetary production economy’ and Wicksell (1898) called a ‘pure credit economy’. Production takes time and is financed by loans from financial institutions or ‘banks’. The nominal liabilities of the financial institutions also represent the only exchange media circulating in the system. The objective of productive activity is to realize monetary profits denominated in terms of bank liabilities. Money is created when loans are extended, and is destroyed via the ‘law of reflux’ when loans are repaid, thus giving rise to the characteristic problems of the monetary circuit (Graziani, 1990; Parguez, 1996). The argument follows Hicks (1982, 1989) in asserting that this structure is as least as reasonable a simplification of contemporary economic reality for theoretical purposes as (say) the assumption of a pure commodity money economy might have been in the heyday of the quantity theory.1 As suggested in the Post Keynesian literature on endogenous money (Kaldor, 1986; Moore, 1988; Lavoie, 1992; Rochon, 1999) in such an environment a short-term rate of interest, rather than the rate of growth of an outside monetary base, is the relevant monetary control variable. Moreover, in current conditions the monetary authorities will likely attempt to target the short-term real rate rather than the nominal rate (Taylor, 1993; Lavoie, 2000; Goodhart, 2002). This they can do by continuously adjusting the administered setting of the nominal rate...

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