Table Of ContentMoney, Interest, and Policy
Money, Interest, and Policy
Dynamic General Equilibrium
in a Non-Ricardian World
Jean-Pascal Be´nassy
The MIT Press
Cambridge, Massachusetts
London,England
62007MassachusettsInstituteofTechnology
Allrights reserved. Nopart of thisbook maybereproduced inanyform by any
electronic or mechanical means (including photocopying, recording, or informa-
tionstorageandretrieval)withoutpermissioninwritingfromthepublisher.
MIT Press books may be purchased at special quantity discounts fro business or
sales promotional use. For information, please email [email protected]
.edu or write to Special Sales Department, The MIT Press, 55 Hayward Street,
Cambridge,MA02142.
This book was set in Times New Roman on 3B2 by Asco Typesetters, Hong
KongandwasprintedandboundintheUnitedStatesofAmerica.
LibraryofCongressCataloging-in-PublicationData
Be´nassy,Jean-Pascal.
Money,interest,andpolicy:dynamicgeneralequilibriuminanon-Ricardian
world/Jean-PascalBe´nassy.
p. cm.
Includesbibliographicalreferencesandindex.
ISBN-13:978-0-262-02613-0(alk.paper)
1.Money—Mathematicalmodels. 2.Equilibrium(Economics)—Mathematical
models. I.Title.
HG220.5.B46 2007
339.503—dc22 2006046859
10 9 8 7 6 5 4 3 2 1
Contents
Introduction ix
Part I Ricardian and Non-Ricardian Economies 1
1 The RicardianIssue and the Pigou Effect 3
1.1 Introduction 3
1.2 The Traditional Ricardian Model 3
1.3 Monetary Puzzles 5
1.4 An Overlapping Generations Model 9
1.5 The Pigou E¤ect 12
1.6 Conclusions 16
1.7 References 16
Appendix A: Government Spending 17
Appendix B: Money intheUtility Function 18
2 Pigou Reconstructed: The WeilModel 23
2.1 Introduction 23
2.2 The Model 24
2.3 The Dynamicsof theEconomy 26
2.4 The Pigou E¤ect 28
2.5 Intertemporal Equilibrium and a Dynamic Equation 30
vi Contents
2.6 AGeneralization: DecreasingResources 31
2.7 The AutarkicInterest Rate 32
2.8 Conclusions 34
2.9 References 34
Appendix A: Money in the Utility Function 35
Appendix B:ExistenceConditions 38
Appendix C:Proofof Proposition 2.2 41
Part II Interest, Prices, and Money 45
3 Liquidity Effects 47
3.1 Introduction 47
3.2 Liquidity E¤ects in a Simple IS-LM Model 47
3.3 The Model and Monetary Policy 49
3.4 DynamicEquilibrium 50
3.5 Liquidity E¤ects 51
3.6 AStronger Liquidity E¤ect 53
3.7 The Persistenceof theLiquidity E¤ect 54
3.8 Conclusions 56
3.9 References 56
Appendix: Proofsof Propositions 3.1 and 3.2 57
4 Interest Rate Rules and Price Determinacy 63
4.1 Introduction 63
4.2 The Model and Policy 64
4.3 The Dynamic Equilibrium 65
4.4 RicardianEconomies and the Taylor Principle 66
4.5 Determinacy under an InterestRate Peg 67
4.6 Taylor Rules 68
4.7 EconomicInterpretations 69
4.8 The TaylorPrinciple with aPhillips Curve 70
4.9 Generalizations 73
4.10 Conclusions 76
4.11 References 76
Appendix: InterestRate Pegging with VariableInterestRates 77
5 Global Determinacy 79
5.1 Introduction 79
5.2 The Model 79
Contents vii
5.3 Ricardian Economies and the TaylorPrinciple 82
5.4 Non-RicardianEconomies: Dynamics and SteadyStates 84
5.5 The Financial Dominance Criterion 86
5.6 Local Determinacy and Financial Dominance 87
5.7 Non-RicardianDynamics: AGraphical Representation 89
5.8 GlobalFinancial Dominance 90
5.9 Partial Financial Dominance 92
5.10 InterestRate Rulesand Global Determinacy: Examples 96
5.11 Conclusions 98
5.12 References 99
Appendix A: GlobalDeterminacy inRicardian Economies 99
Appendix B: Global Determinacy: Equilibria of Type R 100
Appendix C: Transversality Conditions 103
6 Fiscal Policy and Determinacy 107
6.1 Introduction 107
6.2 The Model 108
6.3 The DynamicEquations 109
6.4 Ricardian Economies and Determinacy 109
6.5 Local Determinacy in the Non-Ricardian Case 112
6.6 GlobalDeterminacy 115
6.7 Conclusions 119
6.8 References 119
Part III Optimal Policy 121
7 A Simple Frameworkfor Policy Analysis 123
7.1 Introduction 123
7.2 The Model 123
7.3 GeneralEquilibrium Relations 125
7.4 Optimality 127
7.5 Optimal Policies in Walrasian Equilibrium 129
7.6 Conclusions 130
7.7 References 131
8 Government Information and Policy Activism 133
8.1 Introduction 133
8.2 The Sargent-Wallace Argument 134
8.3 The Model 137
viii Contents
8.4 General Equilibrium Relations 138
8.5 Preset Wages 139
8.6 Preset Prices 146
8.7 Conclusions 149
8.8 References 150
9 Fiscal Policyand Optimal InterestRate Rules 151
9.1 Introduction 151
9.2 The Model 152
9.3 General Equilibrium Relations 153
9.4 Optimal Interest Policy: The Walrasian Case 154
9.5 Preset Wages 155
9.6 Preset Prices 158
9.7 Conclusions 163
9.8 References 163
Appendix: Imperfect Competition and Demand Satisfaction 163
10 Inflation and OptimalInterestRate Rules 169
10.1 Introduction 169
10.2 The Model 170
10.3 Market Equilibrium 171
10.4 Preset Prices 172
10.5 Inflation asa Surrogate for Shocks 175
10.6 Variable Contract Length 178
10.7 Conclusions 182
10.8 References 182
Appendix: Proofsfor Chapter 10 183
Bibliography 189
Index 195
Introduction
Monetary Economies and the Ricardian Issue
The object of this book is to construct rigorous models that bridge the
current gap between a number of monetary intuitions and facts, and re-
cent macroeconomic modeling in the area of dynamic general equilib-
rium. Currently the most popular models in this area are Ricardian (in a
sense that will be made clear just below). Ricardian models have been
successful on several points but nevertheless produce disturbing puzzles
and paradoxes on a number of important monetary issues. A central
theme of this book is that moving to so-called non-Ricardian models
allowsone to solve many of these problemsin one shot.
Ricardian versus Non-Ricardian DynamicModels
One of the most important developments in macroeconomics in recent
years has been the replacement of traditional ad hoc macroeconomic
modelsbydynamicstochasticgeneralequilibrium(DSGE)macromodels,
where all decisions are taken by fully maximizing agents (consumers and
firms).
Of course there are many possible types of DSGE models as there are
many types of general equilibrium models. The most popular DSGE
modelisastochasticversionofthefamousRamsey(1928)model.House-
holds in the economy are represented as a homogeneous family of
