Joshua R. Hendrickson

REDUNDANCY OR MISMEASUREMENT? A REAPPRAISAL OF MONEY

The emerging consensus in monetary policy and business cycle analysis is that money aggregates are not useful as an intermediate target for monetary policy or as an information variable. The uselessness of money as an intermediate target is driven, at least in part, by empirical research that suggests that money demand is unstable. In addition, the informational quality of money has been called into question by empirical research that fails to identify a relationship between money growth and inflation, nominal income growth, and the output gap. Nevertheless, this research is potentially flawed by the use of simple sum money aggregates, which are not consistent with economic, aggregation, or index number theory. This paper therefore reexamines previous empirical evidence on money demand and the role of money as an information variable, using Divisia monetary aggregates. These aggregates have the advantage of being derived from microtheoretic foundations, as well as being consistent with aggregation and index number theory. The results of the reevaluation suggest that previous empirical work might be driven by mismeasurement.

The Political Economy of Bitcoin

The recent proliferation of bitcoin has been a boon for users but might pose problems for governments. Indeed, some governments have already taken steps to ban or discourage the use of bitcoin. In a model with endogenous matching and random consumption preferences, we find multiple monetary equilibria including one in which bitcoin coexists with regular currency. We then identify the conditions under which government transactions policy might deter the use of bitcoin. We show that such a policy becomes more difficult if some users strictly prefer bitcoin because they can avoid other users holding currency in the matching process.

Nominal GDP Targeting and the Taylor Rule on an Even Playing Field

Some economists have advocated nominal GDP targeting as an alternative to the Taylor Rule. These arguments are largely based on the idea that nominal GDP targeting would require less knowledge on the part of policymakers than a traditional Taylor Rule. In particular, a nominal GDP targeting rule would not require real-time knowledge of the output gap. We examine the importance of this claim by amending a standard New Keynesian model to assume that the central bank has imperfect information about the output gap and therefore must forecast the output gap based on previous information. Forecast errors by the central bank can then potentially induce unanticipated changes in the short term nominal interest rate, distinct from a standard monetary policy shock. We show that forecast errors of the output gap by the Federal Reserve can account for up to 13% of the fluctuations in the output gap. In addition, our simulations imply that a nominal GDP targeting rule would produce lower volatility in both inflation and the output gap in comparison with the Taylor Rule under imperfect information.

Money, Liquidity, and the Structure of Production

We use a model in which media of exchange are essential to examine the role of liquidity and monetary policy on production and investment decisions in which time is an important element. Specifically, we consider the effects of monetary policy on the length of production time and entry and exit decisions for firms. We show that higher rates of inflation cause households to substitute away from money balances and increase the allocation of bonds in their portfolio thereby causing a decline in the real interest rate. The decline in the real interest rate causes the period of production to increase and the productivity thresholds for entry and exit to decline. This implies that when the real interest rate declines, prospective firms are more likely to enter the market and existing firms are more likely to stay in the market. Finally, we present reduced form empirical evidence consistent with the predictions of the model.

The Bullionist Controversy: Theory and New Evidence

The Bullionist Controversy in the United Kingdom is one of the first debates about the determination of the price level and the exchange rate under a paper money standard. Despite the importance of the debate in the development of monetary theory, there remains little empirical evidence that uses modern, multivariate time series techniques. The evidence that does exist provides support for the Anti-Bullionist position that the balance of trade determines the exchange rate and thereby the price level. The purpose of this paper is to review the debate and develop a dynamic general equilibrium model that is capable of capturing key features of the 19th-century British financial system. The model is estimated using Bayesian techniques to test the competing hypotheses. The paper provides support for the Bullionist position.

Turning Pink Slips into Red Tape: The Unintended Effects of Employment Protection Legislation

This paper presents evidence on the link between employment protection legislation (EPL) and the rate of unemployment in a cross-country panel data set of OECD countries from 1985-2013. We use both a traditional panel specification with lags of the policy variable, and also a unique structural panel vector autoregression (PVAR) method to determine the long-run dynamic interaction between employment protection legislation and unemployment. We confirm that more restrictive EPL for permanently employed workers causes a significant and persistent increase in unemployment, but the effect is only apparent at long lag lengths, some 2-5 years after the law has been implemented.

Monetary Policy and the Interest Rate: Reflections on Allan Meltzer's Contributions to Monetary Economics

The monetary framework developed by Karl Brunner and Allan Meltzer emphasized the interaction between the supply and demand for money and the supply and demand for credit. In a general equilibrium setting, the money market and the credit market jointly determine the short term interest rate and the price level of real assets. Open market operations change the composition of assets and, in turn, the price level of real assets and the interest rate. The effect of monetary policy on real activity depends on both the change in the interest rate and the change in the price level of real assets. The Brunner-Meltzer model therefore emphasizes the role of changes in relative prices of financial and real assets in response to changes in monetary policy. In recent years, the Federal Reserve has moved to a system that uses the interest rate on reserves as the primary tool of monetary policy. In doing so, the Federal Reserve has implicitly accepted the idea that monetary policy is entirely transmitted through the short term nominal interest rate. In this paper, I present Brunner and Meltzers view of monetary transmission and their critique of monetary models that exclusively focus on the interest rate. In addition, I argue that the lack of evidence in support of the interest rate channel in conjunction with the change in the Federal Reserves operating procedures presents an opportune time to revisit the Brunner-Meltzer critique.

The Riksbank, Emergency Finance, Policy Experimentation, and Sweden's Reversal of Fortune

At the beginning of the 18th century, Sweden was an imperial power that had just sustained a century of modest economic growth. In 1800, Swedens empire was gone, after a series of military defeats. Real GDP per capita had fallen to the same level as the early 1600s. In other words, the 18th century witnessed the end of the Swedish Empire and a startling reversal of economic progress. In this paper, I propose a possible explanation for both of these outcomes. First, I argue that Swedens limited fiscal capacity played an important role. The creation of the Riksbank should have facilitated government borrowing and military spending as the Bank of England did for the British. However, the Riksbank was not designed or equipped for this role. I document the constraints on financing national defense through the Riksbank and argue that the bank was ill-equipped to finance an adequate national defense. This explains the reversal of the empire. Second, when the Hats took power in the Riksdag in 1739, they used the Riksbank to give loans to firms, which were financed through the issuance of bank notes. The objective was to increase investment and economic activity. I find no evidence that these loans had any effect on real GDP per capita. However, the resulting inflation has a negative and significant effect on output during the period of inconvertible paper money. The combined evidence suggests that Hat policy contributed to the decline in economic activity during the reversal of fortune.

Jurg Niehans and the Cashless Economy

Information technology has the potential to decrease substantially, if not completely, the demand for base money. This poses a problem for central banks as it seemingly eliminates a role for monetary policy, at least in the traditional sense. Recently, it has become commonplace to consider the role of monetary policy and the determination of the price level without any reference to money. The two predominant methods of analysis in this regard are the New Keynesian framework articulated by Woodford and the fiscal theory of the price level as described in Cochrane. Lost in the literature on “cashless” economies is the work of Jürg Niehans who, driven by the perplexities of the Eurodollar market, considered the role of monetary policy and price-level determination in the context of a neoclassical macroeconomic model. This article contrasts the framework and conclusions of Niehans with the contemporary approaches. It is argued that Niehans successfully anticipated the conclusions of the fiscal theory of the price level. JEL Classification : E52, E63

Staying When the Going Gets Tough: The Equivalent Predictions of Option and Search Theory on Migration during Economic Downturns

We show that both option and search theory suggest that workers should be less likely to migrate out of labor markets in which there is greater uncertainty about future economic opportunities. The intuition for this result is that, the more volatile the labor market, the greater the likelihood of such opportunities improving in the future. This result weakens the standard prediction that workers should migrate out of markets experiencing relative economic downturns.