bain_y_howells__monetary_economics__policy_and_its_theoretical_basis

38 MONETARY ECONOMICS
Prescriptive definitions of money
An entirely different approach is to decide on the theoretical nature of the
relationship of money with other important variables in the economy and
then to define money so as to show that this relationship exists in practice.
In other words, one starts with a model of the economy in which ‘money’
plays a clear role, with the nature of that role depending on the assumptions
underlying the model. Here we provide two examples of how particular
views of money can be derived from simplified models of the economy in
Section 2.2. Once we have the model, we seek a definition of money that
validates the model.
Let us assume that we believe money to be neutral. That is, ‘money’ is
a set of assets changes in the value of which have no impact on real variables
such as output and employment. We then hope to define money in
such a way that empirical tests show this neutrality. Alternatively, we might
begin with the view that inflation is caused by a too rapid growth of the
money supply. A corollary of this is that the demand for money is stably
related to real income. Thus, a demand for money function is constructed,
using what seems to be the most likely definition of money for the purpose.
However, if the function turns out not to be stable, the definition of money
may be changed until a definition of money is found for which demand does
appear to be stable. This extremely pragmatic approach is strongly supported
by Milton Friedman and reflects the statement quoted above that
‘money is what money does’. The underlying belief is that there must be
something, the rate of growth of which is closely linked to the rate of inflation,
and we may call this something ‘money’. The only problem is the
practical one of finding an empirical counterpart to the theoretical idea.
Money is thus defined in the way that yields the most accurate predictions.
This is an example of a general approach to economics that sees the predictive
power of models as all-important. It should not worry us unduly if the
assumptions made in the construction of models that predict accurately
appear to be unrealistic.
It remains that this approach to defining money can lead to frequent ad
hoc adjustments to the definition in an attempt to produce the correct
answer. Given the problems associated with definitions of other variables
in the functions, the dubious quality of many of the statistics being
employed and the complexity of the time lags involved, there is a danger of
exercises of this kind becoming more interesting for the range of econometric
techniques used than for any light shed on important economic relationships.
It follows naturally that economists who do not start by believ-