A Reinterpretation of the so Called Money Market
Pforzheim University of Applied Sciences Discussion Paper
30 Pages Posted: 16 Jan 2006
Date Written: November 2005
In this paper, the macroeconomic market equations of a closed economy with flexible prices are set up by taking explicitly care of the fact that the central bank offers money as a credit on the capital market. Applying Walras' Law to this system of market equations shows that it is not possible to reduce the system by one equation. Instead the capital market transforms into the equation which is commonly called money market. Consequently, the problem discussed by Patinkin (1969) does in fact not emerge, if monetary policy is modeled in an institutionally correct way. This implies that it is not a real balance effect that restores a general equilibrium after a monetary shock, but a real credit effect. An economic explanation for this mathematical result is given and the effects of monetary policy in both versions of the model are shown to yield the conventional results. Finally, an empirically testable hypothesis of the real credit theory is presented.
Keywords: monetary policy, monetary analysis, money market, Walras' Law, Patinkin controversy, real balance effect, real credit effect, inflation, deflation, money supply, money demand, banking sector, open market operation
JEL Classification: E5, E51, E52, E58, E31
Suggested Citation: Suggested Citation