Credit-Market, Interest Rate and Three Types of Inflation

Abstract

Credit-Market, Interest Rate and Three Types of Inflation

The paper develops an analytic framework explaining the joint determination of interest rates on financial assets, market value of real capital (or real rate of return on real capital) money stock and total “bank credit”. These four magnitudes emerge from the responses of public, banks and monetaryfiscal authorities conditioned by the interaction of assetmarkets. An important characteristic of the analysis ıs the differentiation between money demand and asset-supply (i.e., loan demand and implicit supply of securities to banks). The properties of money demand and asset supply differ substantially in crucıal respects. This differentiation implies in particular that the standard analysis of the superiority of an interest target policy based on the relatively dominant variability of the LM curve cannot be subsumed under our analysıs. It also implies that the transmission of monetry impulses does not 'depend on the absolute magnitude of the interest elasticity of money demand. It depends on the other hand on the realtive magnitude of the interest- elasticities on credit-market and money-market. The structure of the model also implies that the real rate on financial assets and the real rate on real capital do not always coincide or even move together. The analyse of short-run responses of asset-market interactions established cases of divergent responses in the two real rates. The longer-run repercussions via the output-market modify the results, however, and the two rates converge in the long-run. Divergent movements of the two rates are thus an essential element of short-run adjustment processes. Movements in the market rate of interest were organized into an impact effect, an intermediate-run feedback effect and a long-run feedback effect The impact effect is determined by the interaction of asset-markets without feedbacks via any other markets. It was also shown that this impact effect cannot be interpreted as a liquidity effect. The intermediate-run feedback effect depends on the repercussions via the output-market. The long-run effect depends on the other hand on the operation of price expectation mechanisms. The interaction of those effects implies that short-run and longer-run effects of monetary impulses differ in sign, and that short-run and longer-run consequences of Wicksellian or Keynesian impulses differ in magnitude. Three types of inflations were distinguished and their consequences with respect to credit-markets examined. It was shown that the behavior of interest rate and equity values relative to output prices differentiates between the major types of inflation. A financial inflation determines a given level of real base and real securities with a constant real rate of interest. Changes in these magnitudes require an acceleration or deceleration of inflation. Moreover, changes in the real rate of interest induced by variations in the magnitude of the inflationary impulse are negligible compared to the associated changes in the nominal rate of interest. The Wicksellian and Keynesian inflation exhibit a substantially different pattern. A constant rate of inflation continuously raises the real rate. It follows that the nominal rate also continuously rises even with fully adjusted and constant anticipations of the inflation rate. The nominal rate can be determined under a financial inflation to a first approximation by the rate of inflation. Under a Wicksellian or Keynesian inflation the nominal rate is determined to a first approximation by the whole past history of the inflation rate. The longer the inflation and the larger past inflation values, the larger are real and nominal rates of interest. The Wicksellian and Keynesian inflation exhibit thus sımilar patterns with respect to the real rate on financial assets. They differ, however, with respect to the movement of the relative price of real capital. In a Wicksellian inflation equity values rise relative to output prices, and in a Keynesian inflation these values fall relative to output prices. On the other hand, equity values do not change relative to output prices under a financial inflation. A systematic study of interest rates and equity values should thus yield some information on the relative frequency or prevalence of the various inflationary motor forces