The monetary base or M1? results from a small macromodel

This article investigates the issue of whether M1 or the monetary base should be used as an intermediate target for monetary policy. Because the target variable should be reliably related to future economic activity, each aggregate is used in estimating a small macromodel which consists of a nominal GNP growth equation and an inflation specification. The empirical results indicate that M1 better explains GNP growth and inflation for the period 1960–1980. Forecast errors of GNP growth from 1970–1980 are reduced when M1 is used instead of the adjusted base, although there is little difference between inflation forecasts. Based on the evidence presented in this study, M1 is preferred as the intermediate target variable.