Allan H. Meltzer

English

Research Papers in Economics

II[~I Et~
MAY/JUNR 1995
Reply to
Wright’s
Commentary
Allan H. Meltzer
andall Wright has several complimentary
c( things to say aboutsome of my earlier
• ‘Swork, I thank him for those remarks,
Most ofhis comment, however, fails to discuss
my current paper, and the main comments he
makes about the paper are untrue. Specifically,
my paper does not attack theory or oppose
the development ofmicro-foundations for
macroeconomics, It is not about economic
policy Ia ma ta loss to understand how a
reader could come away with either an idea
or with a belief that lam critical ofrecent
work on economic development and growth.
The paper proposes specific hypotheses
for analyzing the role ofmoney and uncer-
tainty The foundation is a micro-theory in
which there isproduction for inventory
Uncertainty about the duration of observed
changes gives rise to costs of information,
The reason is that permanent and transitory
changes cannot be distinguished for some
time after a change occurs, In this model,
money is privately and socially valuable
because it reduces costs of transacting and
bearing uncertainty
I use this framework to discuss three
problems related to the questions that the
organizers asked me to address: (1) why
some prices are set; (2) why some firms set
nominal prices; and (3) why some prices are
sticky—have substantiallyless variance weekly
or monthly than prices in auction markets,
I give explicit references to papers in which
the framework is more fully developed
or in which it hasbeen used fruitfully in
empirical studies,
I contrast this framework with others in
which there are no sticky prices, no produc-
tive or useful mediums of exchange, no dii’-
ferences in costs of acquiring information,
and no distinction between money bonds
and capital that would enlarge the role ofrel-
ative price changes in the transmission of
monetary and real shocks. Ia mcritical of
models with one open marketinterest rate
and no sticky prices, and models in which
money is introduced as a socially costly way
to overcome frictions in an othenvise fric-
tionless Walrasian model, I am skeptical of
some of the conclusions drawn from such
models,
Wright gives considerable space to
methodological issues. Although the models
we use influence the way we look at the
world, it is a mistake to confuse the model
with the world. Science, well done, does not
equate the model to the world; it recognizes
that all useful models generate refutable
propositions. The weak testing procedure
called calibration that is now fashionable is a
distant substitute for serious, careful assess-
ment of competing hypotheses.
Much recent work, including real business
cycle models or overlapping generation models
ofmoney; have implications that are readily
refuted, For example, it is well established
that all correlations between money and
income are not the result of “reverse causa-
tion” and that all unemployment is not the
result ofintertemporal substitution,
I have proposed an alternative model in
which uncertainty and costs oftransactions
and information have a large role. Monetary
arrangements (and other institutions) reduce
these costs, but some costs are unavoidable.
Wright’s comment reports on some of
the research that is now under way or that
has been published in the recent past. As
always, some of this work will prove fruitful,
some not. There is a high cost ofinforma-
tion and great uncertainty about which will
be successful,
It is my view that progress on the impor-
tant issue about how a monetary economy
adjusts to changes or shocks will require
more attention to uncertainty about the
FEDERAL REESRVE BANK OF ST. LOUIS
125II F~1IF~
MAY/JUNR ‘995
permanence of shocks and to costs of
information and transactions. That view
may prove right or wrong, but it is neither
atheoretical nor anti-theory.
I respectWright’s past work and looked
forward to his comments. I regret that he
avoided discussion of the issues raised in my
article and my proposals for dealing with
them. Such a discussion is overdue.
FEDERAL RESERVE BANK OF St. LOUIS
126

Information, sticky prices and macroeconomic foundations : reply to Wright's commentary.

http://research.stlouisfed.org/publications/review/95/05/response_May_June1995.pdf

Information, sticky prices and macroeconomic foundations : reply to Wright's commentary.

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