Main Textbook: Cao, J. and G. Illing, “Money – Theory and Practise”, Draft, Version Sept. 2016
Tutorial 1: The Role of Money
A selection of historical essays on the demand for money and the quantity theory (also see Chapter 19 in Mishkin’s textbook for a summary):
- Keynes (1936): “General Theory of Employment, Interest, and Money", Chapters 13-15, 17
- Friedman (1956): “The Quantity Theory of Money - A Restatement”
- Friedman (1970): “A Theoretical Framework for Monetary Analysis"
Also see the Bank of England’s primer on the role and importance of money in the modern economy.
Tutorial 2: The Term Structure of Interest Rates
Have a look at the CES lecture series by Michael Bauer for a more intensive treatment of yield calculations, yield curves and a primer on term structure modelling.
Consider the following sources for yield data (also look at methodology section to understand how yields are calculated and how these databases differ!):
- Federal Reserve H.15 release / U.S. Treasury: Constant Maturity Treasury rates
- Gürkaynak, Sack and Wright (2007): Smoothed zero-coupon Treasury yields
- Fama and Bliss (1987): Unsmoothed zero-coupon Treasury yields
Tutorial 3: Vector Autoregressions
Historically, different approaches were pursued to identify the effects of monetary policy on output and inflation. Studies of long run effects include Mc Candless and Weber (1995) and Barro (1996). An overview of the different methodologies to study short run interactions is provided in Chapter 1.3 of the Walsh textbook.
Vector Autoregressions, initially suggested by Christopher Sims (1980), is the state-of-the-art approach in empirical macroeconomics to study these short run interactions. Stock and Watson (2001) provide an intuitive primer on VARs. You can find many additional overview slides online, including these two examples [1,2].
More fancy VAR-based methodologies include time-varying VARs, regime-shifting VARs, VARs with sign restrictions and many more…
Tutorial 4: The Taylor Rule
A related concept to describe and evaluate (careful!) monetary policy is the Taylor Rule which was popularized by John Taylor in a series of paper in the 1990s including the original and a modified version of the rule. (Note that the original paper refers to the discussion of discretionary versus rules-based monetary policy which we will cover in a later tutorial in more detail.)
Recently, Taylor-style policy rules have also been used to gauge the monetary policy shortfall associated with the zero lower bound on the nominal interest rate, see Rudebusch (2009). As an exercise, try to update the data provided on this website and use the same estimation approach to update the Rudebusch paper. Also use different measures of inflation and the output gap to get a feeling for the sensitivity of these results.
Yet, keep in mind that there are several problems associated with these rules in particular when it comes to the evaluation of monetary policy. As an example, have a look at the debate about the FED’s policy during the Great Inflation of the 1970s between Clarida, Gali and Gertler (2000) and Orphanides (2002) and the importance of using real-time data.
Tutorial 5 and 6: Money in Macroeconomic Models
In these two tutorials, we discuss money demand functions and their microfoundation in macroeconomic models. Both tutorials are based on Chapters 8.2 and 8.3 in the Obstfeld and Rogoff textbook.
As a starting point, have a look at the Cagan (1956) study of 7 hyperinflationary episodes including the experience in Germany in the early 1920s. Cagan argues that real money demand depends only on expected price increases since the influence of real factors (income or the real rate) is either constant or negligible during episodes of high inflation. (Think about what this means in terms of the Quantity Equation we discussed in the first tutorial!) This specification allows us to attribute price increases to changes in fundamentals and the effects of expectations.
Moving one step further, we discuss microfoundations of money demand in macroeconomic models. The two standard approaches include Cash-in-Advance models and Money-in-the-Utility models. These differ in their treatment of money holdings as a (typically binding) constraint for consumption expenditures or a direct input in the utility function. The first approach emphasizes explicitly the transaction demand for money whereas the latter one also includes the role of money as a store of value.
These frameworks were particularly widespread until the early 1980s – remember the monetarist approach of Milton Friedman and the monetary targeting frameworks of the FED or BoE – but their importance declined once the major central banks (with the notable exception of the Bundesbank repealed explicit monetary targets against the background of money demand instability. In a later tutorial, you will see how the standard modern macro models feature “cashless” economies. (Foreshadowing?)
With the recent advance of unconventional monetary policies – not so recent when you are Japan – interest in these frameworks has revived. In particular, they are used to explain economic stagnation and the (in)effectiveness of unconventional monetary policy. For instance, Paul Krugman’s modern treatment of the liquidity trap is based on a Cash-in-Advance framework. In addition, a widespread approach to explain secular stagnation considers a special version of a Money-in-the-Utility model. (Have a look at the CES lecture slides by Yoshiyasu Ono.)
Tutorial 7 and 8: Seignorage and Public Debt
These two tutorials focus on the interactions of monetary and fiscal authorities. We discuss the role of seignorage, the sustainability of public debt as well as the possibility of multiple equilibria in government debt markets.
The concept of seignorage comprises all revenues that the government obtains due to its monopoly over the provision of money including but not limited to the idea of an inflation tax. Seignorage also creates an important link between the central bank and the fiscal authority. It has gained particular attention in the discussions about the introduction of the Euro, the quantitative easing programs of major central banks and helicopter money. (More information on the idea of helicopter money can be found here and here.)
When do governments default? Liquidity and solvency of sovereigns are harder to capture and evaluate than those of corporations which is why the analysis focuses on both a government’s ability to pay and its willingness to pay the various creditors. Ability to pay seems to be more relevant for low income countries and countries that are not able to borrow in their domestic currency abroad. It’s also a prominent feature of the Debt Sustainability Analysis Framework of the International Monetary Fund the basics of which we will cover in Tutorial 7. Willingness to pay seems to be of greater concern for countries that borrow in their domestic currency. An extensive overview of different frameworks for debt sustainability analysis can be found here.
We typically think of interest rates in sovereign debt markets as primarily reflecting the credit risk of the sovereign issuer (relative to a risk-free benchmark). In that view, high market yields simply reflect the increased probability of default due to a country’s deteriorating macroeconomic and political fundamentals (see the seminal Eaton and Gersovitz paper). An alternative view highlights the potential for multiple equilibria in bond markets and government defaults due to self-fulfilling expectations. We will discuss the contribution by Calvo (1988) - see Corsetti and Dedola (2016) for a modern version of the same idea – and apply the concept to the crisis in the Euro area.