Rethinking the Implications of Monetary Policy: How a Transaction Role for Money Transforms the Predictions of Our Leading Models

ver the past several decades, economists have devoted ever-growing effort to developing economic models to help us understand how changes in interest rates brought about by monetary policy actions affect the production and provision of goods and services in the economy. Although New Keynesian models have broad appeal in explaining how changes in the money stock can affect business activity, these models generate results that are inconsistent with what we know about how interest rates move with policy-induced changes in the money stock. In this article, Julia Thomas argues that by extending the New Keynesian model to reintroduce money’s liquidity role, we can resolve some of the remaining divorce between economic theory and the patterns observed in the workings of actual economies.