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Simultaneous Determination of Interest and Prices in Switzerland by a Two-Market Model for Money and Bonds

Jurg Niehans
Heidi Schelbert-Syfrig

Abstract

This paper presents a quarterly two-market model of the Swiss money and credit markets from 1947 to 1963. The model explains interest rates, the price level, and the quantity of money and bonds in terms of real wealth, real output, the monetary base, and the volume of government bonds and bank portfolios. The quarterly series of investment and output are derived from annual data by what is believed to be a new method of interpolation. The demand and supply functions are assumed to be linear in the first differences of logarithms. The parameters of the four equations are estimated by two-stage least squares. Of the 14 estimates all but one have the theoretically expected sign and all but two are significant at 5 per cent. The interest elasticities of money demand and bond supply are clearly negative, while the interest elasticities of money supply and bond demand, though the former is not significant, are positive. Estimating the same functions separately by ordinary least squares is shown to produce considerably different results; in particular, price and interest elasticities are much smaller in this case. The simultaneous estimates imply that price changes were mainly determined by investment activity and by changes in the monetary base, both with the expected positive sign. Interest rates, on the other hand, are positively affected by investment, output, and the supply of bonds by the government and the banking system, while the monetary base has a negative effect. The quantity of money is mainly, but not exclusively, determined by the monetary base. The volume of bonds, finally, is dominated by investment.