bain_y_howells__monetary_economics__policy_and_its_theoretical_basis

Pause for thought 7.8:
THE TRANSMISSION MECHANISM OF MONETARY POLICY 189
Compare the notion of the net wealth of the private sector with Friedman's version
of wealth in Section 5.8. Why does no one include human wealth in the net wealth
of the private sector?
In considering whether there is a wealth effect, we must first look at the
notion of wealth being used here. It is usual to refer to the net wealth of the
private sector. We divide the economy into three sectors: the private, the
public sector, and the foreign. The net wealth of the private sector is defined
to include all private sector assets that are not also liabilities of other members
of the sector—that is, it includes private sector assets for which the corresponding
liabilities are those of the public sector or the foreign sector.
Thus, many financial assets are excluded because they create corresponding
liabilities within the private sector. For example, equities are assets to
shareholders but are liabilities of firms within the sector. If we rule such
assets out, we are left with four categories of asset to investigate:
• real assets;
• assets that are liabilities of the foreign sector;
• inside money; and
• assets that are liabilities of the public sector.
The first two are straightforward. Both real assets held by the private
sector and private sector assets that are liabilities of the foreign sector are
clearly part of private sector net wealth. However, there are measurement
problems. There are severe difficulties in measuring the net value of the
stocks of private sector housing and consumer durables. Thus, in most studies,
only the capital stock of firms is included as part of private sector net
wealth. The value of foreign assets can alter rapidly with changes in
exchange rates.
Inside money, remember, consists of bank deposits, which are assets to
the holders of the deposits but are liabilities to the banks with which they
are held. Since banks are part of the private sector, some attempts have been
made to exclude inside money from the definition of private sector net
wealth. This, however, ignores the fact that the whole monetary system is
based upon the presumption that banks do not have to repay deposits and
need only hold small prudential balances to meet the day-to-day calls upon
them. If we add central bank willingness to act as lender of last resort to
ensure that the system does not fail, it seems reasonable to accept inside
money as a part of private sector net wealth.