Discussion Paper Details

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Title: The Monetary Transmission Mechanism

Author(s): Jess Benhabib and Roger E A Farmer

Publication Date: May 1996

Keyword(s): Business Fluctuations, Indeterminacy and Sunspots

Programme Area(s): International Macroeconomics

Abstract: In this paper we take as given that market economies are characterized by a set of stylized responses to increases in the stock of money. Innovations to the stock of money lead to increased output and reductions in short-term interest rates in the short run and only in the long run do nominal prices respond. These features of the monetary transmission mechanism have been discussed at least since David Hume. Most authors have attributed the real effects of money in the short run either to mistaken expectations or to non-market clearing or both. In this paper we argue that neither of these channels is needed to explain the facts. We show that a competitive market clearing model in which money enters the production function is fully capable of mimicking the broad features of the data. Our argument relies on an explanation of ?price stickiness? that exploits a multiplicity of equilibria in a rational expectations model.

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Bibliographic Reference

Benhabib, J and Farmer, R. 1996. 'The Monetary Transmission Mechanism'. London, Centre for Economic Policy Research.