Money, Credit, and Prices in a Real Business Cycle

As an alternative to the monetary theories of the business cycle advanced by Lucas (1973) and Fischer (1977), a class of real business cycle models is developed that can account for the relation between the quantity of money, inflation, and cyclical fluctuations in economic activity in terms of reverse causation. The analysis builds upon the earlier work of Tobin (1963) and Fama (1980). The model predicts, in the absence of central bank policy response, that movements in external money measures should be uncorrelated with real activity. Annual data from 1953-1978, used to conduct preliminary empirical analysis, lend support to the alternative framework. Two principle observations are drawn from this work: 1. Much of the contemporaneous correlation of economic activity and money seems to be with inside money, with inflation mainly resulting from changes in the stock of fiat (outside) money and variations in real activity. 2. Future work in this area should consider policy responses that are broad enough to produce variations in outside money that are correlated with real activity.