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Money, Financial Instability and Stabilization Policy

Edited by L. Randall Wray

Money, Financial Instability and Stabilization Policy consists of original articles by leading Post Keynesians, Kaleckians and other heterodox economists from the developed and developing world. Post Keynesian literature has long been associated with the study of money, financial markets and financial instability. Indeed, this is perhaps the area to which Post Keynesians have made the greatest contributions. The authors to this volume present an overview of the latest research on monetary theory and policy, financial markets, and financial instability coming out of the Post Keynesian school of thought. They provide an indication of the wide-ranging interests and of the truly international scope of Post Keynesian research. The first half of the volume is theoretical, while the second half includes papers that are either empirical or more focused on specific concerns.
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Chapter 3: System Dynamics of Interest Rate Effects on Aggregate Demand

Linwood Tauheed and L. Randall Wray


Linwood Tauheed and L. Randall Wray Introduction ‘Perverse’ Interest Rate Effects on Aggregate Demand? Heterodox economics has always been sceptical of the Fed’s ability to ‘finetune’ the economy, in spite of the long-running Monetarist claims about the efficacy of monetary policy (even if orthodox wisdom is used to disdain discretion). The canonization of Chairman Greenspan over the past decade and a half has eliminated most orthodox squeamishness about a discretionary Fed, while currently fashionable theory based on the ‘new monetary consensus’ has pushed monetary policy front and centre. As Galbraith argues, lack of empirical support for such beliefs has not dampened enthusiasm. Like Galbraith, the followers of Keynes have always insisted that ‘Business firms borrow when they can make money and not because interest rates are low’ (Galbraith, 2004, p. 45). Even orthodox estimates of the interest rate elasticity of investment are so low that the typical rate adjustments used by the Fed cannot have much effect. Conventional belief can still point to interest rate effects on consumption, with two main channels. Consumer durables consumption, and increasingly even consumption of services and non-durables, rely on credit and, thus, might be interest-sensitive. Second, falling mortgage rates lead to refinancing, freeing disposable income for additional consumption. Ultimately, however, whether falling interest rates might stimulate consumption must depend on different marginal propensities to consume (MPCs) between creditors and debtors. In reality, many consumers are simultaneously debtors and creditors, making analysis difficult because a reduction of rates lowers both debt payments and interest income....

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