Monetary Theory and Policy.

• Author: Fuerst, Timothy S.
• Position: Review

By Carl E. Walsh. Cambridge, MA: The MIT Press, 1998; Pp. xvi, 528. $55.00.

Carl Walsh has done a great service by writing such an excellent graduate-level textbook that masterfully surveys the current state of monetary theory. While I do have some concerns that are discussed below, I should note at the outset that I now use this text for my masters-level course in monetary theory. While imitation may be the highest form of flattery, appearing on the syllabus must be a close second.

The text begins with a discussion of empirical evidence on the monetary-transmission mechanism, with a major emphasis on the past decade's vector autoregression (VAR) approaches. Walsh succinctly summarizes a fundamental difficulty in this work: "If policy is completely characterized as a feedback rule on the economy, so that there are no exogenous policy shocks, then the VAR methodology would conclude that policy doesn't matter . . . [but] it does not follow that policy is unimportant; the response of the economy to nonpolicy shocks may depend importantly on the way monetary policy endogenously adjusts" (page 33). This policy endogeneity issue is an important theme throughout the text.

Chapters 2-4 survey standard issues in the welfare cost of inflation, seigniorage, and Friedman's optimum quantity of money. Walsh utilizes a general equilibrium money-in-the-utility-function (MIUF) environment but also includes a discussion of shopping-time, transactions cost, and cash-in-advance models (there is also a brief discussion of the Kiyotaki-Wright search models of money). The text repeatedly makes the important point that all of these aggregative monetary models can be mapped into an MIUF environment but that each modeling assumption places restrictions on the form of the utility function.

Unfortunately, Walsh does not take this modeling implication seriously, as he utilizes preference specifications that are hard to justify either empirically or theoretically. For example, in the calibration-simulation experiments in Chapter 2, Walsh uses a preference specification (equation 2.38) that implies that the money demand interest and income elasticities are the same and are both equal to unity. There is no theoretical reason to link these two elasticities, and I know of no empirical estimate of the interest elasticity that is this high. I would have much preferred a more general preference specification that could be calibrated to empirical estimates of money demand. This...