Money, Equity Values, and Income: Tests for Exogeneity

Abstract

MOST MONETARY ECONOMISTS can agree with the broad sketches presented by Professors Friedman [7, pp. 68-72] and Tobin [2] of the mechanism by which monetary policy actions and financial disturbances are transmitted to the markets for goods and services. For instance, starting from an initial position of equilibrium, a central bank purchase of government securities from the banking system lowers the rate of interest on these securities and increases bank reserves. Banks, finding themselves with excess reserves, will expand their loans and investments, thereby bidding up the prices of other financial assets. As the process continues, and the initial effects spread beyond the banking system, rates of return on financial assets will become low relative to the rates available on the claims to existing nonfinancial assets. Thus, investors will tend to bid up the prices of these claims, which in turn become expensive relative to currently produced capital assets. This discrepancy between the valuation of real assets in financial and product markets will encourage the increased production of these goods and will thereby lead to an increase in

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