Prof. Bryan Caplan

Econ 918

http://www3.gmu.edu/departments/economics/bcaplan

Spring, 1998

Monetary Economics Syllabus

Course Focus:

This course will try to fulfill two goals. First, it will expose students to a wide variety of influential ideas in academic monetary economics. Second, it will focus on monetary topics where GMU students have a comparative advantage in the production of new research.

Prerequisites:

I assume familiarity with the standard neoclassical toolkit of mathematical and econometric methods; more advanced techniques will be covered as necessary during class. It will also be helpful if you have digested first-year graduate micro and macro, although I don't mind if you take this class concurrently so long as you can keep up.

Texts:

The following texts are required, and should be available in the bookstore. You might save money by ordering online from e.g. Amazon (http://www.amazon.com) or Laissez-Faire Books (http://www.lfb.org), especially if you do the orders for several friends at the same time.

Robert Barro, Macroeconomic Policy

Barry Eichengreen, Golden Fetters

Milton Friedman and Anna Schwartz, A Monetary History of the United States

Murray Rothbard, America's Great Depression

Also required:

William Haraf and Phillip Cagan, Monetary Policy for a Changing Financial Environment; I suggest ordering it online (http://www.barnesandnoble.com carries it, for one).

George Selgin, Theory of Free Banking; this is out of print, but several book order services appear to still have it; I've also heard that IHS has copies in its book room.

(If there is difficulty getting copies of either of these, I will have the copy center make copies of mine for sale.)

George Selgin, Less than Zero; these have been ordered directly from the publisher, and will be sold to you in week 2 or 3.

There are two types of articles: ones you can download and print from JSTOR (http://www.jstor.org), and those you can't. A reader containing most of the latter type will be available at the copy center. (The remaining pieces will simply be handed out in class).

The quantity of reading assigned is moderate, but you are expected to carefully read (and re-read) all of the readings. The readings will play an important role in lecture, homework, and exams.

For supplementary reading, you may consult the outlines from courses taught by Cowen, Bernanke, and Woodford.

Grading and Exams:

There will be one midterm and a final exam. The midterm counts for 30%; the final exam is 50%; homework counts for the remaining 20%. These weights are fixed - improvement on later exams will not retroactively raise your grades on earlier exams.

There is no formal grade for participation, but if you are one of the students who (in my judgment) contributes most to the quality of class discussion your grade will be raised if you are on the borderline.

Homework:

There will be approximately six homework assignments during the semester. Depending upon how good a job you do, your homework will receive a check-plus (4 points), a check (3 points), or a check-minus (2 points) if you turn it in; otherwise you receive 0 points. Late homework loses one point. Late homework is no longer accepted after I pass out my suggested answers for a given assignment.

Office Hours

The best way to contact me is by email at bcaplan@gmu.edu. Many questions and requests can be satisfied by going to my homepage at http://www3.gmu.edu/departments/economics/bcaplan. My office is in 326 Enterprise Hall; my office number is 3-1124. My official office hours are MWF 1:30-2:30, but you can also schedule an appointment or just drop by and see if I’m available.

Tentative Schedule:

My proposed schedule for the semester follows. If it proves too ambitious, I will try to simply say less about each topic rather than cut the topics for the final weeks.

Articles marked with a * are available on JSTOR (http://www.jstor.org) , so they won't be in the reader. They are of course still required reading. Pieces to be handed out in class are marked with a +.

Week 1: Theories of Money Demand

Money in the utility function
Price level, nominal interest rates, real income, real wealth, substitute assets and money demand
The equation of exchange
Velocity and money demand
Cash-in-advance models of money demand

Readings:

Friedman, Milton. "Quantity Theory of Money," from The New Palgrave.

Azariadis, Intertemporal Macroeconomics. Cambridge, MA: Blackwell, 1993, pp.377-392.

Week 2: Theories of Money Supply

The monetary base
Broader money supply measures and money substitutes
Endogeneity of broader money supply measures
Income or interest rate endogeneity?
Fiscal theories of money supply: seigniorage and the unpleasant monetarist arithmetic

Readings:

* King, Robert and Plosser, Charles. "Money, Credit, and Prices in a Real Business Cycle," American Economic Review, June 1984, pp. 363-379.

Sargent, T.J. and Wallace, N. "Some Unpleasant Monetarist Arithmetic," Quarterly Review, Federal Reserve Bank of Minneapolis, Fall 1981.

Mankiw, Gregory. "The Optimal Collection of Seigniorage: Theory and Evidence," Journal of Monetary Economics, 1987, pp. 327-341.

Barro, Macroeconomic Policy, chapter 13.

Week 3: The Quantity Theory of Money

The quantity theory of money as a theory of money demand
The quantity theory of money as a theory of velocity
Empirical performance of the quantity theory
P* models

Readings:

Friedman, Milton. "Quantity Theory of Money," from The New Palgrave (continued.)

* Hallman, J., Porter, R. and Small, D. "Is the Price Level Tied to the M2 Monetary Aggregate in the Long Run?," American Economic Review, September 1991, pp. 841-858.

Week 4: Rational Expectations and Money

Rational expectations and perfect foresight equilibria
The short-run and the long-run Phillips curve
Solving simple RE models
Hyperinflation and RE
RE models with price rigidities

Readings:

Azariadis, Intertemporal Macroeconomics, pp.25-30; pp. 413-423.

Barro, Macroeconomic Policy, chapter 2.

Calvo, G. "Staggered Prices in A Utility-Maximizing Framework," Journal of Monetary Economics, 1983, pp. 383-398.

* Blinder, "Why Are Prices Sticky?," American Economic Review, May 1991.

Week 5: The Austrian Theory of the Business Cycle and Rational Expectations

The structure of production and monetary policy
The Austrian theory of boom and bust
Unemployment and the Austrian theory
What's right and what's wrong about ABC
The RE critique of (part of) ABC

Readings:

Rothbard, America's Great Depression, chapters 1-3.

+ Cowen, "The Austrian Claim"

+ Caplan, "Why I Am Not an Austrian Economist"

Week 6: The Optimal Rate of Inflation

The costs of inflation and Friedman's deflation rule
The case for zero inflation
The case for the productivity norm - and moderate deflation
The case for moderate inflation

Readings:

Haraf and Cagan, chapter 6.

Bordo, Michael and Jonung, Lars. "Monetary Regimes, Inflation, and Monetary Reform," Stockholm School of Economics, 1996, No. 156.

Selgin, George. Less Than Zero

Akerlof, G. A., Dickens, W. T. and Perry, G. L. "The Macroeconomics of Low Inflation," Brookings Papers on Economic Activity, 1996, pp. 1-76.

Week 7: Banking

The transactions-costs theory of banking
The liquidity-insurance theory of banking
The delegated monitoring theory of banking
Bank runs and bank insurance
Alternatives to banking

Readings:

Bhattacharya, S. and Thakor, A. V. "Contemporary Banking Theory," Journal of Financial Intermediation, 1993, pp. 2-50.

Fama, Eugene. "Banking in the Theory of Finance," Journal of Monetary Economics, 1980, pp. 39-57.

* Diamond, D. and Dybvig, P. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, June 1983, pp. 401-419.

* Calomiris, C. and Kahn, C. "The Role of Demandable Debt in Structuring Optimal Banking Arrangements," American Economic Review, June 1991, pp. 497-513.

MIDTERM

Week 8: Credit Market Imperfections + Exogenous Central Banking

Imperfect enforceability and collateral
Asymmetric information
Credit rationing
Central banking after RE
Interest, money, inflation, and nominal GDP targeting

Readings:

Townsend, Robert. "Optimal Contracts and Competitive Markets with Costly State Verification," Journal of Economic Theory, 1979, pp. 265-293.

+ Bernanke, B. and Gertler, "Agency Costs, Net Worth, and Business Fluctuations," Review of Economic Studies, March 1989, pp. 14-31.

Bernanke, B. and Mishkin, F. "Central Bank Behavior and the Strategy of Monetary Policy: Observations from Six Industrialized Countries," NBER Macroeconomics Annual, 1992.

Haraf and Cagan, chapters 1, 3.

Barro, Macroeconomic Policy, chapter 8.

Week 9: Endogenous Central Banking: The Public Choice Approach to Money

Seigniorage revisited
Time consistency problems and reputation
Rules and time consistency
Central bank independence and time consistency
Political business cycles

Readings:

Alesina, A. and Summers, L. "Central Bank Independence and Macroeconomic Performance: Some Comparative Evidence," Journal of Money, Credit and Banking, May 1993, pp. 151-162.

Walsh, Carl. "Central Bank Strategies, Credibility, and Independence," Journal of Monetary Economics, 1993, pp. 287-302.

* Rogoff, Kenneth. "The Optimal Degree of Commitment to an Intermediate Monetary Target," Quarterly Journal of Economics, 1985, pp. 1169-1190.

Barro, Macroeconomic Policy, chapters 1-3.

+ Bordo, M. and Kydland, F. "The Gold Standard as a Rule: An Essay in Exploration," Explorations in Economic History , October 1995, pp. 423-464.

Week 10: Privatizing Money, I: Commodity Standards

100% reserve standards
Fractional reserve standards
The gold standard era in perspective
Privatizing the mint

Readings:

White, Lawrence H. "What Kinds of Monetary Institutions Would a Free Market Deliver?," Cato Journal, Fall 1989, pp. 367-391.

Bordo, M. "The Gold Standard, Bretton Woods, and Other Monetary Regimes: A Historical Appraisal," NBER Working Paper, March/April 1993.

Sumner, Scott. "Privatizing the Mint," Journal of Money, Credit and Banking, February 1993, pp. 13-29.

Rothbard, Murray N. "The Case for a 100 Per Cent Gold Dollar." In In Search of a Monetary Constitution, ed. by Yeager, Leland B. Cambridge, MA: Harvard University Press, 1962, pp. 94-136.

Friedman and Schwartz, A Monetary History of the United States, chapters 3-4.

Week 11: Privatizing Money, II: Free Banking

A working definition: Freedom of banknote issue; unregulated reserves; unregulated portfolios, and uninsured banks
How the market determines banks' reserve ratio
Banks' optimal response to shifts in money demand
Advantages and disadvantages of free banking

Readings:

Selgin, G. A. and White, L. W. "How Would the Invisible Hand Handle Money?," Journal of Economic Literature, December 1994, pp. 1718-1749.

Selgin, G. A. Theory of Free Banking, chapters 1, 4, 5, 7, 8, 9, 11 (required); the remainder is recommended.

*Gorton, G. and Mullineaux, D. "The Joint Production of Confidence: Endogenous Regulation and Nineteenth Century Commercial Clearinghouses," Journal of Money, Credit and Banking, November 1987.

Week 12: Privatizing Money, III: Further Alternatives to Central Banking

Multi-commodity standards
Competing fiat currencies
Systems without a monetary base
Legal restrictions theories

Readings:

Selgin, G. A. and White, L. W. "How Would the Invisible Hand Handle Money?," Journal of Economic Literature, December 1994, pp. 1718-1749 (continued.)

Friedman, M. and Schwartz, A.J. "Has Government Any Role in Money?," Journal of Monetary Economics, 1986, pp. 37-62.

Wallace, Neil. "The Relevance of Legal Restrictions Theory," Cato Journal, Fall 1986, pp. 613-616.

Week 13: The Great Depression

The monetary explanation triumphant: from Friedman and Schwartz to Eichengreen and Bernanke
Is there an RBC explanation?
Is there an institutional/regulatory explanation?
Does the Austrian theory complement the monetarist explanation?

Readings:

Friedman and Schwartz, A Monetary History of the United States, chapter 7 (required); chapters 5-9 (recommended)

Eichengreen, Golden Fetters, chapters 8-9 (required); chapters 1-7 (recommended).

Bernanke, Ben. "The Macroeconomics of the Great Depression: A Comparative Approach," Journal of Money, Credit and Banking, February 1995, pp. 1-28.

Bordo, Michael, Choudhri, Ehsan U. and Schwartz, Anna J. "Could Stable Money Have Averted the Great Contraction?," Economic Inquiry, July 1995, pp. 484- 505.

Rothbard, America's Great Depression, chapters 4, 7, 11; remaining chapters are recommended.

Week 14: European Unemployment

Real rigidities: efficiency wages and insider-outsider models
European unemployment vs. the Great Depression
Is there a monetary explanation?
Is there an RBC explanation?
Is there an institutional/regulatory explanation?

Readings:

Katz, Lawrence. "Efficiency Wage Theories: A Partial Evaluation," NBER Macroeconomics Annual, 1986, pp. 235-276.

*Lindbeck, A. and Snower, D. J. "Cooperation, Harassment, and Involuntary Unemployment: An Insider-Outsider Approach," American Economic Review, March 1988.

Siebert, Horst. "Labor Market Rigidities: At the Root of Unemployment in Europe," Journal of Economic Perspectives, Summer 1997, pp. 37-54.

Nickell, Stephen. "Unemployment and Labor Market Rigidities: Europe versus North America," Journal of Economic Perspectives, Summer 1997, pp. 37-54.

FINAL EXAM