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The dynamics of monetary aggregates and prices in high-inflation countries

Posted on:1997-06-13Degree:Ph.DType:Thesis
University:Harvard UniversityCandidate:Khoo, Oon-Chye LawrenceFull Text:PDF
GTID:2469390014983551Subject:Economics
Abstract/Summary:
This thesis models the transmission of increases in reserve money to broad money and to prices. The first chapter examines the lag in the effect of increases in broad money on inflation. The last two chapters examine the phenomenon of high excess reserves that occur during periods of high inflation. The study of the dynamics of money and prices has concentrated on the estimation of money demand equations. In general, money demand models imply that prices adjust instantaneously to cover any increases in money supply, and that even in the short run, real money balances fall when the growth rate of money accelerates; both assertions are empirically implausible. Previous attempts to explain this discrepancy have been problematic. It is shown that a partial adjustment model for inflation answers both problems. The inflation partial adjustment model allows past inflation rates to directly affect price setting behavior, and implies that inflation has inertia and follows an augmented AR(1) process. Empirical evidence from high inflation periods reject the standard models in favor of the inflation partial adjustment model. Without taking into account the persistent nature of inflation, estimates of future inflation will be seriously incomplete. It has been observed that excess reserves rise and the money multiplier falls when an economy enters high inflation. The converse occurs during a stabilization. Previous explanations for this phenomenon are inconsistent with the statistical data. It is shown that a dynamic model of the money-creation process (or the multiplier effect) can explain this phenomenon. The money-creation process in a two-tiered banking system occurs with a lag, as the payment cycle that generates the effect occurs at a finite speed. Observed fluctuations in excess reserves and the money multiplier during high inflation, are artifacts caused by high reserve money growth and the lag in the money multiplier. Data from several high inflation periods are shown to be largely consistent with the dynamic money creation model.
Keywords/Search Tags:Inflation, Money, Prices, Model
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