Integrating Monetary Theory and Mainstream Macroeconomics

University Of Pennsylvania, Philadelphia PA

Investigators

Abstract

Mainstream macroeconomics has for a long time adopted what may be called a reduced-form approach to money, which means that it makes assumptions such as "money in the utility function'' or "cash in advance" that proxy for a deeper, more explicit, model. Such short cuts can be useful, but most scholars agree it is better to make things explicit. At the same time, there has been considerable success recently developing serious microfoundations for monetary theory. However, this work on has not had that much of an impact on the mainstream: even those who might applaud the efforts to build a better microfoundations for monetary economics end up dismissing the approach because it is just too distinct from what they know and do. The current proposal involves an ongoing project that attempts to reduce the gap between theories with relatively serious microfoundations and mainstream macroeconomics. It is now possible to analyze general models that capture the standard search-theoretic monetary model and textbook macro model as special cases. It remains to explore the implications of these integrated models. It seems clear they will generate new and interesting insights, both theoretical and quantitative, into the role of money and monetary policy in the economy. Broader impacts resulting from the proposed activity Monetary policy is a big concern in modern economies. Policy makers or their advisors are forced to appeal to theories and models that do not do a very serious job of explaining or analyzing the role of money in the first place, and that often contain logically inconsistent assumptions. This is because there are no real alternatives -- models that try to do a serious job of explaining and analyzing the role of money and that try to maintain logical consistency are too far removed from reality (and even from mainstream macroeconomic theory). The proposed research will reduce this gap between serious theories and practical policy. In the not too distant future, perhaps we will have better monetary policy because of a better understanding of monetary theory, and how it fits in with macroeconomics, more generally.