Acknowledgments
This is a revised draft of remarks made at the “Symposium on Woodford's 2003 Interest and Prices” at the Annual Meeting of the History of Economics Society, Victoria University, Toronto, Canada, June 25–28, 2004.
Notes
1Benigno and Woodford Citation(2003) develop this integrated theory, building upon the theory of monetary policy presented in Interest and Prices.
2Notable examples include the models of Christiano, Eichenbaum, and Evans Citation(2005), Altig et al. Citation(2005), and Smets and Wouters (Citation2003, Smets and Wouters (2004).
3See, for example, the comparisons of fit in Smets and Wouters Citation(2003) and in Del Negro et al. Citation(2004).
4It is not obvious that one should do so, because of the payment of interest on these other components of M1. What matters in the computation of χ is actually the aggregate interest lost as a result of holding money balances. If checkable deposits pay an interest rate lower than the rate available on short-term money-market instruments only because of the non-interest-earning vault cash and reserves that must be held in order to provide these deposits, then the aggregate interest lost would only equal the money-market interest rate times the quantity of base money (which would include the vault cash and reserves that back the checkable deposits), which is the calculation proposed in Interest and Prices.
5This does not mean that one might not wish to take into account the fiscal consequences of monetary policy decisions in such countries. In my view, the more important fiscal consequences of monetary policy in these economies relate to the effects of inflation and interest rates on the dynamics of the public debt; Benigno and Woodford Citation(2003) provide an analysis of monetary-fiscal interactions within a cashless framework. Debt dynamics are also the more important source of interrelation between monetary and fiscal policy choices in some developing countries as well. See Giavazzi et al. Citation(2005) for a recent example.
6One advantage of this reformulation of Wicksellian doctrine is that it applies even to a flexible-price/full-information model, in which the natural rate and the actual real rate of interest can never differ in equilibrium. Another advantage is that under rational expectations, there is often not a determinate equilibrium associated with a specified expected path for the nominal interest rate or even for the real interest rate, but there may well be a determinate equilibrium corresponding to a particular expected path for the reaction-function intercept. (This requires that the response coefficients of the central bank reaction satisfy certain inequalities—referred to as the “Taylor principle” in the case of the baseline neo-Wicksellian model.)
7Boianovsky and Trautwein (2004) express skepticism about the same point.
8This is why the observation of Boianovsky and Trautwein that in a frictionless economy “other riskless nominal assets are perfect substitutes for money, so [that] the law of one price rules,” does not imply the conclusion that they draw, namely that “the central bank is then a price-taker, not a price-setter.”
9Additional central-bank balances can also be obtained by returning currency to the central bank. But the amount of currency that is held is always held despite the fact that a higher interest rate is available on overnight deposits at the central bank, and so is held because of some convenience yield attaching to currency balances. In a cashless economy, no currency would be held, and the monetary base would consist solely of interest-earning central-bank balances.
10These include the insight that the postulate of rational expectations can be usefully combined with the hypothesis of wage and/or price stickiness, the use of models with monopolistic competition together with prices chosen in advance as a way of introducing price stickiness into models with optimizing foundations; and the emphasis given to “real rigidities” as a source of sluggish adjustment of the general level of prices to aggregate conditions.