Factors affecting monetary policy in an era of inflation

A money supply-reaction function is developed and estimated within the context of an IS-LM framework to test the responsiveness of the Federal Reserve to the government budget restraint and certain parameters of the model. The results reveal that a large portion of the recent expansion of the monetary base may be attributed to increases in government debt and provide an essential first step in quantifying the inflationary impact of deficits. The monetary base is also expanded in response to increases in inflationary expectations and previous increases in the monetary base, but is not statistically correlated to changes in the unemployment rate or potential national income, or to rises in interest rates caused by sources other than higher inflationary expectations, previous monetary policy, or the Treasury borrowing requirement.