Money, Financial Intermediation and Governance
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Money, Financial Intermediation and Governance

Dino Falaschetti and Michael J. Orlando

Dino Falaschetti and Michael Orlando unify the treatment of the many deeply related topics in money and banking in this wide-ranging book. By continually building on the assumption that economic actors are maximizers, they explain how monetary and financial services, as well as related governance mechanisms, influence economic performance. In this manner, Money, Financial Intermediation and Governance not only lets readers make sense of today’s monetary authorities and financial markets, it lets them see through superficial complexities to the fundamental influences that will shape those organizations for years to come.
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Chapter 6: Money in a Classical Economy

Dino Falaschetti and Michael J. Orlando


THE CLASSICAL ECONOMY’S SUPPLY SIDE The Firm’s Problem and Labor Demand Our investigation of how money relates to economic fluctuations starts with a ‘classical’ model of the macroeconomy – that is, a model that firmly grounds itself on the axiom of maximizing-behavior while setting aside potentially important economic frictions. This approach will let us see how far a simple model goes in rationalizing business cycles, and highlight empirical regularities that deserve further attention. Our classical model develops macro-insights from micro-foundations by defining a firm’s (real) profit ␲ as follows: ␲ ϭ f(L) Ϫ (wրP) L where f transforms labor (L) into output, w denotes a nominal wage for which individuals can trade leisure in the labor market, and P denotes the price level of final goods and services. Before moving forward, we should understand some of this representation’s details. First, the firm’s technology can reasonably be characterized as transforming labor into output at a positive but decreasing rate. Stated more formally, ѨfրѨL Ͼ 0 and Ѩ2fրѨL2 Ͻ 0. This latter condition appreciates the diminishing rate at which fixed capital stocks can augment the productivity of marginal labor units (as well as those units’ contribution to congestion costs). In addition, we’ll define the economy’s price level P as an ‘average’ nominal price for each good and service that an economy produces – for example, the ‘consumer price index,’ or CPI, that popular and business media frequently report. Finally, we’ll assume (and ultimately derive the hypothesis) that input and output prices move...

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