The theory was developed by Keynes [ 24 ] who state that investment decisions are determined by a conducive environment for the investor and a long run survival behavior of an investor. For this to happen the investor need to consider the accumulation of capital which is influenced by lending rates [ 25 , 26 , 27 ]. The longer the investor survive in business, the more the economy can grow [ 26 ].
Keynes theory of investment further compares the marginal efficiency of capital MEC with interest rates [ 26 , 28 , 29 ]. If the MEC exceeds the rates, the investment will be increased. But because the production process demands the use of more and more capital, the MEC will suddenly fall. Once the MEC equals to the level of interest rate, there will not be any additional investments on income-earning assets.
Additionally, Duesenberry [ 28 ] developed the financial theory of investment which assumes that there is a relationship between the cost of capital and interest rates.
The Keynesian theory of investment can be extended to include the effects of all the selected monetary variables on investment. For instance, according to Nucci and Pozzolo [ 30 ], investment is a function of the cost of capital and exchange rate. Also in Amiti and Weinstein [ 31 ] investment can be determined by money supply through bank supplies. It is vital to investigate the influence of monetary variables on investment activities as an investment is an important economic resource needed for economic growth.
Literature suggests that monetary variables such as exchange rate do affect investment levels of a country in several setups. For instance, Osemene and Arotiba [ 32 ] advocate for a stable exchange rate environment to have positive effects of volatile exchange rate on foreign portfolio investment.
These findings are enforced in Teddy [ 33 ] that a high volatile highly unstable exchange rate in Zambia harmed private capital inflows. There are several conditions found in the literature on how the exchange rate can affect investment. These conditions vary depending on the developing state of the country. In Harchaoui, Harchaoui et al. When a domestic currency depreciates, sales of goods and services yield higher revenues and profits. At the same time, the variable cost and imported capital increase to counterbalance the positive effects of higher revenues [ 34 , 35 ].
This is because revenue from both domestic and foreign sales is increased. Nucci and Pozzolo [ 30 ] supported this argument when they investigated the exchange rate- investment nexus for some selected Italian manufacturing firms.
The authors discovered that exchange rate depreciation impacts investment positively through revenue channel and negatively through the cost channel, and added that businesses need monopoly power to achieve this relationship. The most important factors deliberated in the literature about what can cause positive effects of exchange rate on investment are stable exchange rate, monopoly power, the openness of trade, amount of imported inputs and developing level of a country [ 32 , 34 , 36 , 37 ].
For instance, Atella et al. Therefore it can be argued stable exchange rate can benefit any economic system through investment and profits due to its ability to strength firm market power. This enlightens reasons why African countries depreciation of exchange rate would reduce investments as they use a lot of imported inputs with high variable input price.
This explains why a country can benefit from its investment under stable exchange rates with high market power. Money supply shocks can have differentiated effects on the real economy in several ways including investment. For example, Amiti and Weistein [ 31 ] found that money supply in bank loan can significantly determine investment activities, though there was a negative relationship.
To identify the causal effect of money on the real economy, Brzezinski et al. The study made use of local projections and autoregressive models to discover that clean identification requires that the money shock is not correlated with other shocks either contemporaneously, or across time. Karras and Stokes [ 39 ] also found a positive relationship in the money supply investment nexus and argued that investment is governed by asymmetries in money supply shocks which are similar to the ones that affect output.
Many studies established a positive relationship between money supply shocks and investment activities [ 31 , 40 , 41 ]. It is noted that the use of the money supply channel more financial markets and works well to positively influence investments where there are developed financial institutions [ 40 ]. Chen et al. This implies that the money supply can be one of the predictors of investment activities [ 42 ]. However, Gertler and Grinos [ 43 ] have the opposite that reducing money supply can enhance investment.
The relationship between lending rates interest rates and investment is widely understood in the macroeconomic sphere because the interest rate is one of the prospective determinants of investment [ 44 , 45 , 46 , 47 , 48 ].
It has been established in the literature that high-interest rates stimulate savings but harm investment especially of small businesses [ 44 , 49 , 50 , 51 ].
The reasons for these harmful effects are because high-interest rates increase capital cost, and thus discourage investment [ 44 ]. Another view from Malawi and Bader [ 44 ] is that in less developed financial institutions private investment is inhibited by savings. Those are the instances where there is a positive relationship between the interest rate and investment.
Li and Khurshid [ 45 ] used the vector error correction model to investigate the effects of interest rate on investment in a Chinese province named Jiangsu. The study observed that in Jiangsu, interest rate and investment are positively related only in the short-run and negatively related in the long-run.
It should be noted that some scholars believe that interest rates and investment have a one-way relationship. However, M3 is no longer included in the reporting by the Federal Reserve. MZM, or money zero maturity, is a measure that includes financial assets with zero maturity and that are immediately redeemable at par. The Federal Reserve relies heavily on MZM data because its velocity is a proven indicator of inflation.
Money supply data is collected, recorded, and published periodically, typically by the country's government or central bank. The Federal Reserve in the United States measures and publishes the total amount of M1 and M2 money supplies on a weekly and monthly basis. They can be found online and are also published in newspapers. According to data from the Federal Reserve , as of Feb.
In economics, the money supply refers to all of the cash and currency in circulation within a country. In America, the Federal Reserve determines the level of monetary supply. Among the economic schools that closely analyze the role of money supply on economic stability are Monetarism and Austrian Business Cycle Theory. A central bank regulates the level of money supply within a country.
Through monetary policy, a central bank can undertake actions that follow an expansionary or contractionary policy. Expansionary policies involve the increase in money supply through measures such as open market operations, where the central bank purchases short-term Treasuries with newly created money, thus injecting money into circulation.
Conversely, a contractionary policy would involve the selling of Treasuries, removing money from circulating in the economy. In the United States, the money supply is categorized by various monetary aggregates including M0, M1, and M2.
These are used by the Federal Reserve to measure how open market operations impact the economy. The monetary base, or M0, is equal to coin currency, physical paper, and central bank reserves. M1, typically the most commonly used aggregate, covers M0 in addition to demand deposits and travelers' cheques. Meanwhile, M2, which may be used as an indicator for inflation when compared to GDP, covers M1 in addition to savings deposits and money market shares.
Federal Reserve. Is It Important? Federal Reserve Bank of New York. Federal Reserve Bank of St. Your Privacy Rights. In the money model in Table 3 , income increases by units in the first period and then remains at the new level in the next two periods.
The balance of payments deteriorates by 44 units, and, since there is no adjustment mechanism in this model, the deficit is in effect maintained in subsequent periods. In the credit model, income increases by units in the first period and the balance of payments deteriorates by 38 units. In the next period, income is still higher, and this continues to produce a deficit in the balance of payments.
This deficit reduces the money supply and depresses somewhat the level of income below that operative at the end of the first period. In the next period, a smaller deficit depresses further the level of income. In the money model in Table 4 , income falls by units and the balance of payments deteriorates by 56 units. With a fall in income and no change in the money supply, the interest rate will be lower, thus inducing some net capital outflow, which represents a partial offset to the lower imports.
The deficit persists in subsequent periods. In the credit model, the drop in income is larger in the first period because of the fall in the money supply. The deficit progressively declines, but as long as there is a deficit, the money supply and therefore income continue to fall. The behavior of income in periods 2 and 3 is due to the drop in the money supply. The effects of an autonomous capital outflow in the money model in Table 5 are simple. There is no income effect nor any money supply effect, and the deficit in the balance of payments persists indefinitely.
In the credit model, the deficit in the balance of payments remains large because the adjustment mechanism depends only on changes in the money supply. The changes in income are worth comparing with the corresponding changes in income where autonomous exports fall. The initial fall in income is much larger for the exports because exports also affect income directly. However, in subsequent periods, the fall in income is larger for the capital flow because the drop in the money supply is larger.
We now consider briefly the implications of a third model where the control variable is the change in claims held by the central bank. Suppose now that these claims are predetermined in a given period, and suppose that net overseas assets fall by one unit. From equation lOd we can see that base money in the system will now fall by the change in net overseas assets.
Bank assets cannot now be purchased by the central bank, since this will now result in increased holdings of central bank claims. If we disregard this possibility, then the model in this case works differently Since part of the fall in base money cannot be offset by assumption given the claims held by the central bank , a process of multiple deposit contraction cannot be avoided.
Using the United Kingdom as an illustration, x is of the order of 3. For example, for autonomous investment, an increase in autonomous expenditures will have a smaller adverse effect on the balance of payments simply because the contraction in the money supply is now larger.
On the other hand, an increase in claims on government will increase the external deficit, because this will create a larger increase in the money supply. These results are not surprising. Again, a change in claims on government will ultimately create an equivalent adverse effect on the balance of payments, but now changes in other autonomous elements will reduce the long-term reserve loss. This is because the external adjustment mechanism is more efficient in this instance.
Comparing this result with 14a in the text, we can see that the coefficients fall sharply. A unit increase in autonomous expenditures will ultimately worsen the balance of payments by only one unit against 3. In this section we suppose that the monetary authorities maintain a constant interest rate by accommodating the money supply to changes in monetary demand.
The same three autonomous changes may now be considered. The solutions in these cases are simple and may be derived by examining equations 8 and 9. Suppose that autonomous expenditures increase and the increased demand for money is met by the authorities; then the interest rate will be unchanged, and coefficients be and ge will drop out of the equations in the expressions for autonomous expenditures.
If c—0. Here the 0. If exports drop by units, income would fall by about units. This reduces imports by something like 50 units, so that the net adverse effect on the balance of payments would be about 50 units.
An increase of units in autonomous capital outflow is also very simple. There is no income effect, and the balance of payments will deteriorate by units. Table 6 compares, for one period, the results for the four alternative models of three autonomous changes.
When autonomous investment increases, the increase in income is largest in the fixed interest rate model and smallest in the central bank credit model. Again, the deterioration in the balance of payments is largest in the fixed interest rate model and least in the central bank credit model. The reason for these results is simple: in the fixed interest rate model, money supply increases to accommodate the increased monetary needs; in the central bank credit model, the accompanying deficit will reduce the money supply by a multiple of the deficit, and this dampens both the increase in income and the deficit.
For a drop in exports, the largest drop in income and the smallest deterioration in the balance of payments occurs in the central bank credit model. The reason is that the multiple contraction in the money supply produces the largest fall in income and therefore the largest drop in imports.
The money model shows the smallest drop in income and the smallest deterioration in the balance of payments. The solutions for an increase in autonomous capital outflows are simple. The money and fixed interest rate models work in an identical way. The difference between the domestic and central bank credit models is that in the central bank credit model there is a magnified effect on the money supply.
It is difficult to draw any general conclusions from these results. Some of these difficulties may be illustrated by reference to the central bank credit model. For all three autonomous changes, the adverse effect on the balance of payments is least in this model.
The balance of payments, in other words, is most immune to external shocks. In an increase in autonomous investment the effect on income is also minimized, but in the other two instances the change in income is largest in the central bank credit model.
A drop in exports in this model generates the smallest adverse effect on the balance of payments because it is allowed to produce the largest drop in income. In the same way, an increase in autonomous capital outflows will have the least impact on the balance of payments because it will allow the largest drop in income. In the second and third models, therefore, the greater immunity in the balance of payments to external shocks is achieved only at the expense of greater instability in the level of income and employment.
In estimating the coefficients, the United Kingdom was used as an illustration. To begin with, it is easy to assign plausible values for some coefficients: c, the marginal propensity to consume, was given a single value of 0. The figure for the upper limit was derived from Ball and Drake, 14 who estimated the following import equation:. The coefficient for GDP is the marginal propensity to import. This coefficient is almost certainly too high; however, it is used in the text for illustrative purposes.
We would need to know not only the size of the relevant elasticities but also the relative mean values of I, M, Y, and K with R eliminated by substitution. The only problem with this procedure is in the estimation of the g. First, it is difficult to get a meaningful figure for K net short-term capital flows ; second, g e would appear to have little meaning in an equation where the dependent variable was net short-term capital imports, whose value could approach zero. As a result, arbitrary figures of and 20 were used for g.
Elasticities were used for b e , f e , and e e , but a slope value was used for g. On the basis of U. Two values were used for be: 0. There is no empirical work on this for the United Kingdom, but these values are consistent with econometric studies in the United States.
Both coefficients were significant, and both approximated 1. Elasticities for both variables of 0. In Section II of the text we examined the implications of a Keynesiantype model in an open economy where the money supply was allowed to respond to changes in the overseas balance.
It is instructive to contrast this model with a simple Quantity Theory-type model under similar conditions. These equations may now be combined to yield short-term and long-term solutions for the overseas balance. These two solutions may now be compared with the short-term and long-term solutions obtained for the Keynesian model. They are reproduced here:. In the Keynesian model, h is the coefficient for money against the change in the overseas balance see equation 9 ; in the Quantity Theory model, dv is the coefficient for money against the change in the overseas balance substituting vM t for Y t in equation In the Keynesian model, h is a composite of a number of structural coefficients; h ranges, for plausible values of these coefficients, from 0.
In contrast, dv , for plausible values of velocity and the marginal propensity to import, would normally range from 0. Hence, a major difference between the two models is in the likely size of the money coefficient. This may be seen by contrasting the long-term solution for Keynes, 1 h , with the long-term solution for the Quantity Theory, 1 d v ; the total loss in reserves from a unit fall in exports is 1 h in the Keynesian case and 1 d v in the Quantity Theory case. The reason for this difference is that because money is more powerful in the Quantity Theory case, the adjustment mechanism restores long-term equilibrium with a smaller loss of reserves.
On the other hand, it may be seen that the long-term solution for the change in credit is the same in the two models. A once-over increase in credit will in both models generate an equivalent cumulative loss in reserves.
The coefficient for credit in both long-term solutions is 1. It is also interesting to compare the long-term income solutions for the two models. The long-term solution for income for the Quantity Theory is. The coefficient for the change in credit is zero in both instances, as expected, but there are differences between the models for disturbances stemming from changes in exports-capital flows and autonomous expenditures.
Equation 15 now becomes. In this special case, the long-term income solutions are identical. The coefficient for autonomous expenditures becomes zero; income, in other words, cannot be permanently raised by an increase in autonomous expenditure because this would imply a higher level of imports and hence some disequilibrium in the balance of payments.
Where capital flows do respond to interest rate changes, a permanently higher level of income is sustained by higher imports matched by capital flows induced by a higher interest rate. Again the coefficient for exports and capital flows is the same for the two models; under both models a permanent increase in income is possible only when there is a permanent increase in exports or net capital flows.
The most interesting conclusions emerging from these comparisons are the following. The cumulative reserve change for disturbances other than changes in credit is quite different in the two models. The reason for this difference lies in the fact that the adjustment mechanism, i.
For a U. Ball, J. Eaton, and M. LXXVI , pp. In equation 9 if g is sufficiently large i. In this case, an increase in autonomous expenditures will improve the balance of payments. This is true where, with fixed money supply, the rise in the interest rate will improve capital flows by more than the increment in imports owing to the rise in income.
The effect of allowing for these financial and import constraints on income expansion is to lower the multiplier from 2. This disregards complications arising from the fact that different components of expenditure may have different import contents. The model, of course, also assumes that the current and capital accounts are independent. A stock relationship complicates the mechanism of adjustment suggested above. If short-term flows are a function of the change in the interest rate the stock version , then in order to maintain an improved given flow the interest rate would need to be raised continuously.
When money is defined in this way, the terms for domestic credit and net overseas assets should also correspond to this definition in order to satisfy the identity. This was disregarded in the interest of simplicity; also, the results would be changed only mildly by effecting this transformation. Where the foreign impact is allowed for, the domestic expansion will generate some increase in exports; hence, some increase in the money supply in long-run equilibrium will be sustainable.
This point was suggested to the author by an unpublished paper by D. In our model, this must also mean that the rate of interest reverts to its original level, since the rate of interest is determined by income and the money supply, both of which are ultimately unchanged.
Of course, in the progression to equilibrium, the rate of interest will change, and this will result in a temporary movement in short-term capital flows. Movements in capital flows were disregarded in the text. If the increase in credit is constant in each period, the solution will be different. As equilibrium is approached, the money supply increases at a declining rate.
In equilibrium the level of income will be higher, and the periodic increase in credit will leak overseas. This is one case dealt with by J. Central banks, including the Federal Reserve, have at times used measures of the money supply as an important guide in the conduct of monetary policy. Over recent decades, however, the relationships between various measures of the money supply and variables such as GDP growth and inflation in the United States have been quite unstable.
As a result, the importance of the money supply as a guide for the conduct of monetary policy in the United States has diminished over time.
The Federal Open Market Committee, the monetary policymaking body of the Federal Reserve System, still regularly reviews money supply data in conducting monetary policy, but money supply figures are just part of a wide array of financial and economic data that policymakers review.
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