Money And Inflation: An Empirical Study On The Economy Of Taiwan

The influence of money on prices has been disputed for a long time among economistsand policy makers. Money did not matter for many economists until 1970,and then almostall economists accepted that it mattered. However, in over half of the empirical studies,money has failed to convince people of its influence. The purpose of this paper is toinvestigate the influence of money on prices from a different point of view, and to use theTaiwan data to do empirical research.For the sake of understanding the evolution of inflation theory, this paper firstlydescribes the development of inflation theory over time in accordance with the evolution ofmacroeconomics, and then surveys all of the related empirical literature concerning moneyand inflation, examining what makes money matter, and what does not. With respect tothose factors and methods that make money matter we have also carried out empirical testsusing Taiwan data. Finally, we describe our "sufficient"and "necessary"conditionhypothesis.The influence of money on prices is quite different from that of the other factors.During the process of inflation, money plays two roles, when its grourth rate reaches acritical level, there will be a real balance effect, that will create a huge demand thusbecoming the "demand pull inflation". This is a kind of "quantitative"effect, which we callthe "sufficient"condition of inflation. If the growth rate of money does not reach the criticallevel, it will accumulate gradually leading to "tight"or "loose"circumstances, which willinfluence the price mark-up on cost push, a kind of "qualitative"effect, which we call the"necessary condition"of inflation. Traditionally, the empirical study of money and pricesonly took into consideration the "quantitative"effect, with no consideration of the criticallevel. This always leads to the conclusion that money doestn't matter! The "qualitative"effect had been neglected completely. In reality, however, money's qualitative effect is oftenmore significant than the quantitative effect. This empirical study on Taiwan's economysupports our necessary and sufficient condition hypothesis.The "qualitative"effect of money not only influences the cost-push inflation, but alsoaffects the time lag of monetary policy and the variability of relative prices. If thecircumstances for accumulating money in the recent past have been tight, then the time lagbetween money and prices will be longer, and if it has been loose,the lag will be shorter.Because the monetary circumstances are changing all the time, the policy lag is likewisechanging, and then the effectiveness of monetary policy is doubtful. This statementsupports the Monetarists'criticism of the Keynesians'discretionary monetary policy. Inaddition, the monetary circumstances affect the variability of relative prices. Control of themoney supply can not only check inflation and the unnecessary relative price changes, butcan also make the necessary price adjustment owing to the changes in the supply anddemand conditions being executed.The methodologies used in this empirical study ary the ordinary least square method,the dummy variable, and the Almon lag technique. The data used such as the imported price,the wholesale price, the consumer price, money, the interest rate, income, the industrialwages and prices are separately taken from the Quarterly National Income Estimates of theRepublic of China(1961-1979);A Supplement to Financial Statistics Monthly, TaiwanDistrict, the Republic of China 1983,Oct., Financial Statistics Monthly, Taiwan Distrit, theRepublic of China;Commodity Price Statistics Monthly, Taiwan Area.R.O.C.;The data oninternational money and prices, are taken from International Financial Statistics.