The Barnett Critique After Three Decades: A New Keynesian Analysis
NBER Working Paper No. 17885
This paper extends a New Keynesian model to include roles for currency and deposits as competing sources of liquidity services demanded by households. It shows that, both qualitatively and quantitatively, the Barnett critique applies: While a Divisia aggregate of monetary services tracks the true monetary aggregate almost perfectly, a simple-sum measure often behaves quite differently. The model also shows that movements in both quantity and price indices for monetary services correlate strongly with movements in output following a variety of shocks. Finally, the analysis characterizes the optimal monetary policy response to disturbances that originate in the financial sector.
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