Monetary Transmission: Through Bank Loans or Bank Liabilities?

INTEREST IN THE TRANSMISSION OF MONETARY fluctuations to real output has dominated macroeconomics since at least the eighteenth century. Since then, many observers have noted the tendency of a monetary expansion to be followed initially by an expansion of real output, and later by an increase in prices. While the reason for the long-run price change is well understood, understanding the short-run impact of money on nominal output remains an active, unresolved, research topic. Most theoretical models explain the transmission of monetary fluctuations to real output as a consequence of sticky prices or expectations. The stickiness is either due to informational imperfections or to contractual rigidities. While the policy implications of the two types of stickiness differ, both types of model predict a transitory response of real output to a shock in nominal money balances. Neither the informational imperfection nor the contractual rigidity story is completely compelling, and both rely on the central role played by movements in real balances and perceived real interest rates. Yet, for thirty-five years following World War II, neither significant movements in the anticipated real rate nor large interest elasticities of spending were apparent. Despite this, the empirical correlation of money and output fluctuations has been found in most time periods and countries. Consequently, the need for alternative explanations of monetary transmission (or a credible reverse causation story) remains strong.