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 7: Money in a Keynesian Economy

Dino Falaschetti and Michael J. Orlando


It’s not a moving equilibrium. When we have 11 percent unemployment in 1982 or 25 percent in 1932, I don’t regard that as being a labor market equilibrium with supply and demand equal. And I don’t believe that productivity, technology, go up and down in anything like waves which would be consistent with the business cycles we observe. (James Tobin, quoted by Fettig, 1996) INTRODUCTION The classical model offers a firmly grounded rationalization of important macroeconomic phenomena such as inflation (especially hyper-inflation), and even fluctuations in real output. Indeed, prominent contributors to the RBC (real business cycles) literature argue that technology shocks explain 70 percent of the post-war (WWII) economy’s fluctuations (see Rolnick, 1996 and Romer, 2001, Table 4.4). But this model encounters difficulty when attempting to rationalize phenomena such as involuntary unemployment, and fluctuations therein. In addition, persistent reduced form evidence suggests that, at least in the short run, money is not neutral.1 The Great Depression shed a bright light on these difficulties, encouraging that era’s most prominent economist, John Maynard Keynes, to consider how aggregate demand can affect employment and output. A distinguishing feature of these early models is an allowance for nominal rigidities. Recall the classical assumption that constituent prices move together (on average), and its implication that aggregate supply does not vary with the price level but remains fixed at a level consistent with the labor market’s competitive equilibrium. By instead assuming that prices are ‘sticky,’ conventional Keynesian models...

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