Towards a new monetary paradigm: a quantity theorem of disaggregated credit, with evidence from Japan

During the course of the 1980s three major 'anomalies' were observed in a number of countries, including in Japan, which threw doubt on the traditional macroeconomic models: 1. The apparent velocity decline in the quantity equation and the resulting instability of the money demand function; 2. unusually fast rises in asset prices that often came to be referred to as speculative bubbles and which could not be explained by standard asset pricing models; and 3. capital exports from Japan, which reached historic proportions in the mid-1980s, but collapsed in the early 1990s, and which could not be explained by traditional models. In this article I present a simple model that encompasses the standard theory as a special case and which simultaneously can account for the above three 'anomalies'. It is based on a 'quantity equation' of credit creation, which is disaggregated into credit for 'financial circulation' and credit for the 'real circulation'. It is shown that excessive credit creation for financial circulation is responsible for all three 'anomalies'. The model is supported in empirical tests using the general to specific econometric methodology and using Japanese data. The article concludes with a discussion of the implications of these findings for monetary theory, future research and economic policy