FINANCIAL INNOVATION AND THE DEMAND FOR MONEY: EVIDENCE FROM THE PHILIPPINES

This paper tests whether financial innovations in the Philippines distorted the long-run relation between real money balances, income and interest rates. Using data for the monetary base, M1 and M3 over the period 1980–1998, we cannot reject the hypothesis that there does not exist a standard money demand relation between M1 and M3, real income and interest rates. However, when we allow for the impact of financial innovations, this finding is reversed for M1. Estimates of ECM models for these measures also show that financial innovations impacted real money balances for M1, but not M3. This evidence supports the Philippine central bank's choice of a monetary aggregate as its policy instrument to achieve its policy objectives. [E41, E58]     

(In)determinacy, increasing returns, and the optimality of the Friedman rule in an endogenously growing open economy

This paper sets up a monetary endogenous growth model with Benhabib–Farmer production externalities for an open economy, and then uses it to investigate the possibility of indeterminacy. Moreover, the paper examines how the monetary authorities will set its optimal anchor of the money growth rate from the viewpoint of welfare maximization. Several main findings emerge from the analysis. First, when investment does not involve adjustment costs, the monetary equilibrium is locally determinate regardless of the strength of the labor externality and the extent of world capital market imperfections. Second, in the presence of investment adjustment costs, the monetary equilibrium may exhibit indeterminacy when the aggregate increasing returns-to-scale in production is sufficiently strong. Third, in the presence of world capital market imperfections, the Friedman rule of a zero nominal interest rate fails to be optimal. Fourth, in the face of perfect world capital markets, the optimal nominal money growth rate is maintained at the rate that is conformable to the Friedman rule, regardless of whether investment involves adjustment costs or not.     

Some tests for money illusion and distribution effects in the aggregate consumption function

The hypothesis that the aggregate consumption displays money illusion in the sense that consumers mistake an increase in nominal incomes for an increase in real incomes and thus consume more out of given real incomes in response to a rise in the price level and the hypothesis that the aggregate consumption depends on the distribution of income are tested using Finnish annual and quarterly data. The money illusion hypothesis is rejected by annual data, while it meets success with quarterly data. The hypothesis of distribution effects in the aggregate consumption is supported by annual data. Particularly, equalizing the distribution of income would increase the aggregate consumption. In view of the quality of data on personal income distribution this conclusion cannot be regarded as more than tentative.     

Seasonal Cointegration and Long‐Run Neutrality of Money in the USA

Using the notion of seasonal cointegration and a monetarist model, this paper re‐examines the long‐run monetary neutrality hypothesis, based on the seasonally unadjusted quarterly data of the US over the period 1959Q1–2004Q4. The results indicate that money is cointegrated with price at all possible frequencies while real output is cointegrated with price only at an annual frequency. The cointegration between money and price at the zero frequency, and non‐cointegration between real output and money at all possible frequencies, suggests that money affects nominal but not real variables in the long run.     

Exchange rate volatility and the demand for money in the U.S.

This paper examines the effect of changes in the level and volatility of exchange rates on the demand for money. It hypothesizes that exchange rate volatility exerts a negative influence on money demand separate from the effect of the level of exchange rates. Using U.S. data covering the period from 1974.1 to 1990.4, it is found that, regardless of whether the adjustment process is modeled as an error-correction or a partial-adjustment model, exchange rate volatility is negatively related to the demand for real M2 balances. This relationship is found to be more pronounced when exchange rates are expressed in real terms. The results imply that money demand responds to both the volatility of domestic prices relative to foreign prices and to the volatility of nominal exchange rates. Little evidence is found in support of the hypothesis that the level of exchange rates exerts a significant influence on money demand.     

Shocking the eurozone

In this paper, the monetary transmission mechanism within the European Monetary Union is investigated. The impulse response functions and forecast error variance decompositions of a structural vector error correction model (SVECM) are compared with those of a New Keynesian theoretical model. The identifying restrictions of the SVECM are directly derived from the theoretical model. Two permanent shocks are identified, one having only nominal, and one having only real effects. The three transitory shocks comprise a short-term interest-rate shock, an aggregate demand shock and a money demand shock. The main conclusions are that permanently reducing the inflation objective depresses output in the first year, but has no real effects in the long run. Regarding output variability, the results indicate that aggregate demand shocks are most important during the first year, after which aggregate supply shocks dominate.     

Devaluation,Inflation, and the Balance of Payments: A Short-Run Monetary Approach*

In this paper a model is presented to analyze, in a monetary setting, the effects of a once-and-for-all adjustment in the exchange rate in a small economy committed to a fixed exchange-rate system. The effects of such an adjustment are shown to be transitory. After a devaluation the domestic rate of inflation accelerates in relation to the rate of inflation in the rest of the world. The increase in prices reduces the real value of the nominal stock of money and, in order to restore real liquidity to its previous level, foreign-exchange reserves start to flow into the country. However, as monetary equlibrium is reached, the flow of reserves tends to stop and the domestic rate of inflation converges to the world rate.     

Direct effects of money on aggregate demand: another look at the evidence

Now that a number of central banks are faced with short-term nominal interest rates close to or at the zero lower bound, there is a renewed interest in the long-running debate about whether or not changes in the stock of money have direct effects. In particular, do changes in money have additional effects on aggregate demand outside of those induced by changes in short-term nominal interest rates? This article revisits and reinterprets the empirical evidence based on single equation regressions which is quite mixed, with some results supporting and other results denying the existence of direct effects. We use a structural model with no direct effects of money to show that the finding of positive and statistically significant coefficients on real money growth can be misleading. The model generates data that, when used to estimate analogues of the empirical regressions, produce positive and statistically significant coefficients on real money growth, similar to those often found when using actual data. The problem is that single equation regressions leave out a set of variables, which in turn, give rise to an omitted variables bias in the estimated coefficients on real money growth. Hence, they are an unreliable guide to calibrate monetary policies, in general, including at the zero lower bound.     

Does fiscal policy really matter in the context of variable prices?

Blinder and Solow's crowding-out analysis is extended by allowing wealth effects of debt accumulation on both aggregate demand and aggregate supply. Two questions are reexamined; (1) the compatibility relationship between the long-run stability and the sign of the instantaneous money and bond multipliers, and (2) the long-run relative expansionary effect of bond financing. Without capital accumulation, real crowding-out may become compatible with stability under both money and bond financing, while nominal crowding-out is not. Normally, this is also true with capital accumulation. Furthermore, bond financing is not necessarily more expansionary than money financing in either real or nominal terms.     

Monetary Shocks and Real Exchange Rate Hysteresis: Evidence from the G-7 Countries

Long-run monetary neutrality specifies that nominal disturbances do not affect long-run real exchange rates. However, the "over depreciation" of the US dollar in the late 1980s, after its strong appreciation earlier in the decade, suggested to a number of observers that nominal disturbances alter long-run real exchange rates; that is, money supply shocks entail real exchange rate hysteresis. Using data from the G-7 countries and the post-1973 float, the paper measures the long-run effects of relative money supply disturbances on real US dollar exchange rates. Little evidence of hysteretic monetary policy effects is found.     

A causal caveat in the Australian money/income relation

The nature of Australian causal relations between money and nominal income and money and real income is examined. Like other recent studies in the area causality is in the sense of Granger (1969). Unlike other studies, causality conclusions are based on both a within-and post-sample analysis. This is motivated by Granger's(1980) recent suggestions regarding causality detection. Monetary growth is found to lead both real and nominal income growth by six months. Surprisingly, the post-sample forecasting analysis suggests real income rather than nominal income as the more relevant causal variable as far as monetary growth is concerned. The identified lag here is fifteen months.     

Reconsideration of the P-bar model of gradual price adjustment

This paper compares the P-bar model of price adjustment with the currently dominant Calvo specification. Theoretically, the P-bar model is more attractive as it depends on adjustment costs for physical quantities rather than nominal prices, while incorporating a one-period information lag. Furthermore, the resulting adjustment relation is more completely free of “money illusion,” in terms of dynamic relationships, and therefore satisfies the natural-rate hypothesis of Lucas [1972a. Econometric testing of the natural rate hypothesis. In: Eckstein, O. (Ed.), The Econometrics of Price Determination. Board of Governors of the Federal Reserve System], which is not satisfied by the Calvo model in any of its variants. Along the way, it shows that both the P-bar and Calvo models can be formulated in distinct versions in which current real wages are, or are not, allocative. Quantitatively, for a given calibration of the demand parameters, the implied time-series properties of the inflation rate, output gap, and nominal interest rate are determined for various policy parameters, and are compared with quarterly data for the US economy. Neither model dominates but, overall, the comparison seems somewhat more favorable to the P-bar model and certainly does not provide support for the dominant position held by the Calvo model in current monetary policy analysis.     

Is money an omitted variable in the production function? Some further results

In recent years, numerous studies have emphasized the role of real balances in the production function in terms of money being useful: as an intermediate good; as liquid reserves for investment; and also serving as a link between aggregate supply and the nominal interest rate. In this paper we report new Canadian empirical evidence regarding the important role of money in the production process of aggregate manufacturing industries based on a flexible translog cost function approach. In general, our results support the hypothesis that money is an important factor in the production function and that there are potential supply side effects of a change in the interest rate.     

Money, expectations, and interest rates

This paper employs a model of nominal interest rate determination in a framework of rational expectations of inflation. Hypotheses are developed with respect to relative impacts of predictable and unpredictable changes in money supply. These hypotheses are tested using quarterly Italian data from 1966–1975. The nominal monetary base is the measure of money employed and one private and two government bond rates measure nominal interest rates. The results are insensitive to variations in estimation procedure and specification of adjustment processes (and even predictive functions for the monetary base). The rational expectations formulation is well supported in every case.     

Financial market imperfections and monetary policy strategy

In a model with imperfect money, credit and reserve markets, we examine if an inflation-targeting central bank applying the funds rate operating procedure to indirectly control market interest rates also needs a monetary aggregate as policy instrument. We show that if private agents use information extracted from money and financial markets to form inflation expectations and if interest rate pass-through is incomplete, the central bank can use a narrow monetary aggregate and the discount interest rate as independent and complementary policy instruments to reinforce the credibility of its announcements and the role of inflation target as a nominal anchor for inflation expectations. This study shows how a monetary policy strategy combining inflation targeting and monetary targeting can be conceived to guarantee macroeconomic stability and the credibility of monetary policy. Friedman's k-percent money growth rule, which can generate dynamic instability, and two alternative stabilizing feedback monetary targeting rules are examined.     

The response of aggregate demand to income,money supply,and price level

The response elasticities of (nominal) aggregate demand to the price level and to other nominal variables (e.g., money supply) are both positive but smaller than one. Aggregate demand is less/as responsive to real income than/as to the price level in the short/long run. Real aggregate demand is less/as responsive to real income than/as nominal aggregate demand is to the price level in the short/long run. Some uses of these results are indicated.     

MONETARY ANTICIPATONS AND THE DEMAND FOR MONEY SOME UK EVIDENCE*

The Carr-Darby ‘shock-absorber’ hypothesis, that unanticipated changes in the money supply influence the demand for real money balances but anticipated changes do not, is tested on UK data for narrow money, M1. For comparison with earlier studies on US data we take the (real first order) partial adjustment model as one example of a ‘conventional’ demand for money function. However the Carr-Darby hypothesis is also tested taking a more general autoregressive distributed lag model as the ‘conventional’ demand function. For both ‘conventional’ demand for money functions we find that the shock-absorber hypothesis is not supported for M1 using UK data.     

The information content of the divisia monetary aggregates in forecasting inflation in the euro area

The paper investigates the performance of a set of monetary indicators, based on the Divisia money constructed for the euro area, on forecasting euro area inflation. The paper first briefly discusses on the relative information contents of the Divisia aggregates and the simple sum aggregates. The forecasting performance of the former is then examined by means of simulated out-of-sample forecasting. In addition to examining the information contents of the Divisia aggregate constructed for M3 money, the study also examines the performance of the Divisia M1 money to gain evidence on the relative performance between the broad and narrow Divisia monetary aggregates. According to the results, only some of the monetary indicators considered can significantly improve the univariate inflation forecasts. The Divisia M3 money based monetary indicators turned out to perform better than their Divisia M1 based counterparts. The result contradicts some previous evidence on the optimal level on monetary aggregation in the context of broad versus narrow money.      

Data uncertainty and the role of money as an information variable for monetary policy

In this study, we perform a quantitative assessment of the role of money as an indicator variable for monetary policy in the euro area. We document the magnitude of revisions to euro area-wide data on output, prices, and money, and find that monetary aggregates have a potentially significant role in providing information about current real output. We then proceed to analyze the information content of money in a forward-looking model in which monetary policy is optimally determined subject to incomplete information about the true state of the economy. We show that monetary aggregates may have substantial information content in an environment with high variability of output measurement errors, low variability of money demand shocks, and a strong contemporaneous linkage between money demand and real output. As a practical matter, however, we conclude that money has fairly limited information content as an indicator of contemporaneous aggregate demand in the euro area.