Mundell-Tobin effect
Encyclopedia
The Mundell–Tobin effect suggests that nominal interest rate
s would rise less than one-for-one with inflation
because in response to inflation the public would hold less in money
balances and more in other assets, which would drive interest rates down. In other words, an increase in the exogenous growth rate of money increases the nominal interest rate and velocity of money
, but decreases the real interest rate
. The importance of the Mundell–Tobin effect is in that it appears as a deviation from the classical dichotomy
. Robert Mundell
was the first to show expected inflation has real economic effects. A similar argument was introduced by economist James Tobin
.
Nominal interest rate
In finance and economics nominal interest rate or nominal rate of interest refers to the rate of interest before adjustment for inflation ; or, for interest rates "as stated" without adjustment for the full effect of compounding...
s would rise less than one-for-one with inflation
Inflation
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a...
because in response to inflation the public would hold less in money
Money
Money is any object or record that is generally accepted as payment for goods and services and repayment of debts in a given country or socio-economic context. The main functions of money are distinguished as: a medium of exchange; a unit of account; a store of value; and, occasionally in the past,...
balances and more in other assets, which would drive interest rates down. In other words, an increase in the exogenous growth rate of money increases the nominal interest rate and velocity of money
Velocity of money
300px|thumb|Similar chart showing the velocity of a broader measure of money that covers M2 plus large institutional deposits, M3. The US no longer publishes official M3 measures, so the chart only runs through 2005....
, but decreases the real interest rate
Real interest rate
The "real interest rate" is the rate of interest an investor expects to receive after allowing for inflation. It can be described more formally by the Fisher equation, which states that the real interest rate is approximately the nominal interest rate minus the inflation rate...
. The importance of the Mundell–Tobin effect is in that it appears as a deviation from the classical dichotomy
Classical dichotomy
In macroeconomics, the classical dichotomy refers to an idea attributed to classical and pre-Keynesian economics that real and nominal variables can be analyzed separately...
. Robert Mundell
Robert Mundell
Robert Mundell, CC is a Nobel Prize-winning Canadian economist. Currently, Mundell is a professor of economics at Columbia University and the Chinese University of Hong Kong....
was the first to show expected inflation has real economic effects. A similar argument was introduced by economist James Tobin
James Tobin
James Tobin was an American economist who, in his lifetime, served on the Council of Economic Advisors and the Board of Governors of the Federal Reserve System, and taught at Harvard and Yale Universities. He developed the ideas of Keynesian economics, and advocated government intervention to...
.