FALLIBILITY, PRECAUTIONARY BEHAVIOUR and THE NEW KEYNESIAN MONETARY THEORY
| Published date | 01 November 1995 |
| DOI | http://doi.org/10.1111/j.1467-9485.1995.tb01169.x |
| Author | Roberto Tamborini,Marcello Messori |
| Date | 01 November 1995 |
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1995
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FALLIBILITY, PRECAUTIONARY BEHAVIOUR
AND THE NEW KEYNESIAN MONETARY
THEORY
Marcello Messori* and Roberto Tarnborini"*
I
INTRODUCTION
The lack of microfoundations of
the
non-neutrality of money
on
real variables,
which led to the decline
of
Keynesian macroeconomics in the '70s and
'~OS,
has
been a major concern of the so-called New Keynesian Economics (NKE). The
main achievement of the NKE has been to show that money non-neutrality
springs from agents' rational behaviour in the presence of two basic sources of
market imperfections at the micro-level:
adjustment costs on
goods
and labour
markets,
or
imperfect information on capital markets
(e.g. Greenwald-Stiglitz,
1987; Mankiw-Romer, 1991). Both forms of market imperfection exist and
matter
in
economic life; yet they have quite different theoretical implications.
The approach based
on
the adjustment costs concentrates
on
the traditional
issue of 'price stickiness' (Blanchard, 1990; Gordon, 1990). Having rational-
ized price stickiness, the monetary theory implied by these models remains
essentially the same as in the 'neoclassical synthesis'
of
the '60s: money turns
out to have real effects only because prices and wages are sticky. The route to
money non-neutrality taken by the approach of the imperfect capital markets
instead entails a more radical departure from neoclassical monetary theory. The
focus is
on
the effects that the conditions of credit and finance supply exert
on
firms'
production decisions (e.g. Blinder-Stiglitz, 1983; Greenwald-Stiglitz,
1990, 1993). The key point is the violation of the Modigliani-Miller theorem as
a consequence of imperfect information and incomplete future markets. Two
typical equilibria may arise in this context:
equity rationing
and
credit rationing.
These equilibria constrain the economy's activity at an undue low level, while
changes in money supply are non-neutral
on
real variables as they alter the
rationed equilibria
on
the capital markets.
We believe that this latter approach to the non-neutrality of money has far-
reaching implications
for
monetary theory, and highlights important factors in
the failure of the market economy to operate at full capacity (see also Keynes,
1936, ch. 12, 1937; Leijonhufvud, 1969;
Hahn,
1973, 1988). However, in spite
of a wide array of micro-models of capital market failures (see e.g. Fazzari
et
al.,
1988; Gertler-Hubbard, 1988) and
an
early generation of macro-models
(see e.g. Blinder, 1987; Bernanke-Blinder, 1988; Greenwald-Stiglitz, 1990,
1993), a systematic New Keynesian (NK) monetary theory is not ripe.
In
*University
of
Casino, Italy
University
of
Padua, Italy
**
443
444
MARCELLO MESSORI AND ROBERTO TAMBORINI
particular, the focus on means of payment as a production input supplied by the
credit market (‘it is not money that makes the world go around, but credit’,
Stiglitz, 1988,
p.
320) has led the
NKs
to downgrade the importance of some
fundamental issues that are commonly viewed as relevant to the explanation of
the relationships between money and economic activity-such as why money
exists and why it
is
used, above all as store of value, in market economies. The
full development of a
NK
monetary theory can hardly dispense with investiga-
tion of these issues. Hence the aim of this paper is twofold. First, we wish to
outline a unifying theoretical background for a
NK
monetary theory. Second,
we wish to extend the
NK
approach to the issues of the determinants of the
demand for money, and of the working
of
the supply side of capital markets.
As
will be seen, the theoretical approach we propose leads
to
a representation of
the functioning of capital markets consistent with the
NK
view, even
in
the
absence of rationed equilibria, and with a clear link between the motives for
holding money and capital market failures.
In
our
view, the appropriate theoretical background for a
NK
monetary theory
is the one developed by Hicks and some scholars in general equilibrium theory
(see Hicks’s own rendition in
his
last work, 1989; also Hahn, 1982, 1988;
Tsiang, 1989; Ostroy-Starr, 1990) and, with some qualifications that will
be
pointed out below, by the so-called ‘cash-in-advance’ models (Lucas, 1980;
Svensson, 1985), based on
sequential time, uncertainty and incomplete future
markets
as necessary features which make it rational to use money in market
economies. Therefore, in Section
II
we characterize a monetary economy as a
Hicksian sequence economy of spot markets for production services, goods,
finance and credit.
A
Hicksian sequence economy is such that each and all
transactions have to
be
performed whether by means of cash or deferred
payment (liabilities), but
firms
face a production time lag between disburse-
ments for inputs and receipts from output sales,
so
that their operations on the
markets for finance and credit should take place before those on the markets for
goods.
In this sequential framework, the typical
NK
view of money and capital
markets comes into full light. In Section 111, the financial and credit markets are
characterized as the markets which should coordinate economic activity by
transferring money on capital account
to
agents who demand means of payment
to finance their planned expenditure in excess of (or running ahead of) receipts.
We also point out the crucial difference between the two types
of
market: the
financial market exchanges tradable assets and thus redistributes the existing
money stock within the private sector, whereas the credit market operates
through personal debt contracts with the banking system which represent an
addition to the means of payment in the economy.
We then address in Section IV the issue of modelling agents’ sequential
decisions in a monetary economy whose central features are uncertainty and the
lack of future markets. The
NKs
have particularly emphasized the
fallibility
of
firms (i.e. a positive probability of default on monetary commitments:
Greenwald-Shglitz, 1987, 1990, 1993). We argue that in
a
monetary economy,
whenever defemng payments is costly
or
impossible, this problem of fallibility
8
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Economic
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1995
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