Monetary Theory and Policy. Money in the Utility Function

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Monetary Theory and Policy. Money in the Utility Function

Table of Contents

Introduction
Main body
Conclusion
Reference

Introduction

Money is the issue of the economy, due to the political and social, and other factors affecting different aspects of life and household.

Money is an asset, making positive or negative or some other functional effect. Goods, demands, propositions are constantly dependent on the money supply. And the money demand is greatly affected by economical growth. The main point about money, in general, is utility. How do we assume utility from money knowing very well that we cannot consume money but use it to buy consumables, goods and make capital?

First, we have to comprehend what utility is in order to get the meaning of utility of money. Utility in another word is the contentment got from consumer goods, services, etc. For example, we can say the satisfaction of food is feeling full while the utility of medical care is health.

Main body

On the basis of the research given in Monetary Theory and Policy by Walsh, lets try to analyze some monetary economy aspects. It arises the question: How should be the demand for money be modeled. But lets put some other questions to the model, and trace the results. What if the state government is able to promise a constant rate of money growth, then what is the money growth rate, people want?

Many different models of incorporating are known, but all of them are based on main three approaches.

3 approaches to incorporate money into the equilibrium model, that is three types of modeling money:

Assume, that money makes direct utility through incorporating money balance into the parts of the model utility functions.
Impose transactions costs that arise the demand for money, requiring that money be used for concrete transactions, assuming both money and time aspects as the leading factors in the process of consuming goods.
Treat money as no other means of transferring resources with no time factor.

The important conclusion to be drawn from the different models is that whether the main idea is generalized from one and specific model, or it is based on the manner in which the role of money has been introduced.

Walsh exemplifies the ways in which the money role can affect the inflation and steady capital stock of the country.

In his, work Walsh makes the accent on the first approach of incorporating money into the model. The given approach can guarantee the agents of the model a positive money value under the conditions of choosing to hold the positive amounts of money.

Originally, the model was generated by Sidrauski in 1967 and name as a money-in-the-utility function or simply MIU. In this model, not only the consumption of goods and leisure yield direct utility but the possession of currency, as well. Since money itself has no intrinsic value and is only useful in introducing transaction costs, incorporating money in the utility function is not free of criticism.

In this research, the theme of the ordinary citizen and his household factor rises.

Apparently, the currency is not the only factor to enter the utility function. Instead, it is the command over goods or the transaction services value, expressed in terms of goods, that makes sense. Also, we have the constituents as time, Inflation, population, labor, and capital.

Together with Walsh, lets begin with the steady-state condition of the model. The steady-state assets, the capital stock, inflation, real money balances must meet the first-order necessary conditions for solving the household problems, as we look through the prism of a common citizen of the state and his values, the constraint of the budget of the state, and the specification of the external growth rate. In the equitation, it looks as all the components are equal to zero.

And in this conclusion it is evident, under such real economic conditions, per capita money holdings are invariable and, as a result, a constant value of real money balance needs to change with the same rate. As money is assumed to pay no price of interest, the opportunity cost of money holding is dependent both upon the capital real return and the inflation level. And if the price level is ascending, then real money value is getting declined. And if the situation is invariable and the prices do not ascend, then the forgoing earnings are to be returned to the capital.

To make sure that the monetary equilibrium under the steady-state conditions subsists, there must be a positive but limited level of real money balance that meets all the conditions and terms estimated at the steady-state consumption level.

Through chapter 2, of the book Monetary Theory and Policy by Walsh, equations and the specimens of application of the model ambiguous conclusion is evident.

Sidrauskis Money-in-the-Utility Function represents one approach to model the demand for money in an economy. The Sidrauski model allows some welfare comparisons to be made. The model can be used to estimate the welfare costs of inflation and to determine the optimal rate of inflation. Friedmans conclusion is that the optimal inflation rate is the rate that makes a zero nominal rate and the conclusion is quite strong.

Undertaking the investments and holdings of real money balance causes the direct utility, which in its turn, is the issue ensuring definitely positive demand for money. And in equilibrium, under such economic conditions, money is held and has worth.

Although some of their worked-out results considerably differ from those in the literature on the topic, some key effects in the money growth process variations are clearly apparent.

Conclusion

To sum up, the size of the relative risk aversion coefficient shows whether the marginal utility of consumption decreases or increases as to the real money balances and as a result: labor and output respond to a monetary growth shock.

For the criterion values of the models constituents, however, the effects of varying in the rate of the money growth process on output are quantitatively small in the flexible-price model worked out in the research.

Reference

Walsh, Carl. Monetary Theory and Policy 2^nd Ed. Boston: MIT Press, 2003.

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