interest rates and money in the measurement of monetary policy over the last 25 years a set of influential studies has placed interest rates at the heart of analyses that interpret and evaluate monetary policies in light of this work the federal reserve s recent policy of quantitative easing with its goal of affecting the supply of liquid assets appears to be a radical break from standard practice alternatively one could posit that the monetary aggregates when measured properly never lost their ability to explain aggregate fluctuations and for this reason represent an important omission from standard models and policy discussions in this context the new policy initiatives can be characterized simply as conventional attempts to increase money growth this view is supported by evidence that superlative divisia measures of money often help in forecasting movements in key macroeconomic variables moreover the statistical fit of a structural vector autoregression deteriorates significantly if such measures of money are excluded when identifying monetary

benefits conditional on work and the nordic model abstract welfare benefits in the nordic countries are often tied to employment we argue that this is one of the factors behind the success of the nordic model where a comprehensive welfare state is associated with high employment in a general equilibrium setting the underlining mechanism works through wage moderation and job creation the benefits make it more important to hold a job thus lower wages will be accepted and more jobs created moreover we show that the incentive to acquire higher education improves further boosting employment in the long run these positive effects help in counteracting the negative impact of taxation through numerical simulations we show how this mechanism can contribute to explain the better labor market performance and more equitable income distribution of nordic countries compared to continental european ones

maintaining low inflation money interest rates and policy stance abstract this paper presents a systematic empirical relationship between money and subsequent prices and output using us euro area and swiss data since the 1960 1970s monetary developments unlike interest rate stance measures are shown to provide qualitative and quantitative information on subsequent inflation the usefulness of monetary analysis is contrasted to weaknesses in modeling monetary policy and inflation with respectively short term interest rates and real activity measures the analysis sheds light on the recent change in inflation volatility and persistence as well as on the phillips curve flattening and reveals drawbacks in pursuing a low inflation target without considering monetary aggregates

is the price level tied to the m2 monetary aggregate in the long run a long run link between money and prices is evident for the united states since the korean war if the m2 measure of money is used and the velocity of m2 v2 is modeled as a mean reverting series this link between m2 and prices is the basis for a dynamic model of inflation that compares favorably in forecasting exercises with phillips curve and more typical monetarist approaches the behavior of v2 is examined from 1870 to the present providing a basis for reconsidering previous findings that v2 follows a random walk copyright 1991 by american economic association

estimation of current quarter gross national product by pooling preliminary labor market data two methods of using labor market data as indicators of contemporaneous gross national product gnp are developed the establishment survey data are used by inverting a partial adjustment equation for hours a second gnp forecast can be extracted from the household survey by using okun s law using preliminary rather than final data adds about 2 to 4 percentage point to the expected value of the root mean squared errors and changes the weights that the pooling procedure assigns to the two forecasts the use of preliminary rather than final data results in a procedure that assigns more importance to the okun s law forecast

institutional change and the velocity of money a century of evidence we study common features in the income velocity of money income and interest rates for canada the u s the u k sweden and norway using annual data from 1870 the recently developed and refined techniques of testing for cointegration are employed the evidence suggests there is a unique long run relationship in velocity but not in income and interest rates moreover we find that only a model which includes institutional change proxies is properly specified we argue that the evidence is best interpreted in the context of common historical developments in the respective countries financial systems

is inflation always and everywhere a monetary phenomenon using a sample of about 160 countries over the last 30 years we test for the quantity theory relationship between money and inflation when analysing the full sample of countries we find a strong positive relation between long run inflation and the money growth rate the relation is not proportional however the strong link between inflation and money growth is almost wholly due to the presence of high or hyper inflation countries in the sample the relationship between inflation and money growth for low inflation countries on average less than 10 per annum over the last 30 years is weak

financial technology shocks and the case of the missing m2 m2 growth was unusually weak in the early 1990s when its velocity soared although m2 growth subsequently recovered its velocity plateaued at a high level giving rise to a case of missing money these swings in m2 growth have accompanied opposite swings in bond mutual fund inflows m2 growth is better tracked and the missing m2 problem is resolved when money models are modified to account for shifts in bond mutual fund costs this approach avoids the capital gains and portfolio substitution problems posed by adding bond or equity funds to m2 while capturing the substitution effects relevant to money demand

money and prices evidence from the g7 countries this paper examines the exogeneity of money and prices within a money demand vector error correction model the exogeneity of the variables is central to several buffer stock models however the paper makes two modifications to the traditional approach the first is to explicitly acknowledge the importance of the supply of money function by including the function alongside its demand counterpart the second is to estimate the behaviour of the nominal sector and real sector simultaneously overall the results from the g7 countries suggest that the concerns raised by buffer stock models are relevant

stability of a uk money demand equation a bayesian approach to testing exogeneity the paper analyses an m3 demand for money equation for the united kingdom attention is paid to the policy change that occurred in 1971 with the introduction of the measure known as competition and credit control classical and bayesian single equation instrumental variables procedures are developed to investigate the exogeneity of the short term interest rate and the constancy of the parameters of the underlying relationships the parameters of the short term equation have changed as well as the exogeneity status of the interest rate variable but the parameters of the long term equation appear to be less affected by the policy change

alternative p models of inflation forecasts i introduction inflation forecasts play a key role in monetary and macroeconomics during the past three decades dramatic changes in the inflationary environment have stimulated a wealth of studies on the relative accuracy of alternative models of inflation forecasts in particular mehra 1988 stockton and glassman 1987 and reichenstein and elliott 1987 found varying performance in traditional models including the term structure phillips curve and typical monetarist models across postwar periods against this background hallman porter and small 1991 hps introduced a model called p star p sup as inflation forecasters holy grail the p sup framework is built on the general perception that inflation over the long run is a monetary phenomenon however as christiano 1989 argued p sup entails no practical implication for shorter run horizons that are of primary interest to inflation forecasters he further pointed out that for the period of 1970 89 one to three year ahead forecasts from p sup are not meaningfully more accurate than those from traditional models the usefulness of p sup as an anchor for the price level also suffers from another limitation the assumption that velocity which is the ratio of nominal gdp to a monetary aggregate is stable over the long run hps justified the validity of this hypothesis based on postwar 1955 88 data for the broad monetary aggregate m2 used in their model during the early 1990s however the growth rate of m2 apparently slowed down relative to that of gdp leading to a sharp rise in m2 velocity this consequently caused p sup to persistently underpredict actual inflation duca 1995a has provided a detailed discussion on plausible sources of this instability in velocity the literature has also offered plausible solutions to correct p sup models for the observed structural change ranging from redefining the relevant monetary aggregate to directly accounting for a trend break in velocity while evidence supports that these individual methods improve upon the original p sup formulation there is a lack of research comparing their performance especially in periods other than the early 1990s the first objective of the present study therefore is to fill this void the second objective of this paper is to reevaluate the robustness of earlier findings regarding the relative performance of hps s original p sup model to this end we divide the full out of sample forecast period of 1970 96 into three subsamples our results reveal a pattern of switching forecast performance between money based and output based models across recent periods the fragility of these models highlights the extent of temporal instability in the inflation generating process this paper proceeds as follows the next section describes alternative p sup model specifications and other inflation forecast models section iii discusses the forecast results section iv summarizes and concludes ii model specifications the p sup model the benchmark of the p sup model is the quantity theory of money which relies on the equation of exchange 1 p sub t equivalent to m sub t v sub t y sub t where p is the price level m is a measure of money supply v is the velocity of money y is the level of output real gdp and a time subscript denotes the current value of a variable it follows that if v sub t and y sub t reach their long run equilibrium levels at mathematical expression omitted and mathematical expression omitted respectively then the current equilibrium price level mathematical expression omitted can be determined as 2 mathematical expression omitted according to hps mathematical expression omitted is measured by the historical mean of v sub t and mathematical expression omitted by the level of potential gdp

interpreting euro area inflation at high and low frequencies abstract several authors have recently interpreted the european central bank s ecb s two pillar framework as separate approaches to forecast and analyse inflation at different time horizons or frequency bands the ecb has publicly supported this understanding of the framework this paper presents further evidence on the behaviour of euro area inflation using band spectrum regressions which allow for a natural definition of the short and long run in terms of specific frequency bands and causality tests in the frequency domain the main finding is that variations in inflation are well explained by low frequency movements of money and real output growth and high frequency fluctuations of the output gap

economic reforms and long run money demand in china implications for monetary policy although money demand equations have been estimated for many western countries only recently have researchers investigated the demand for money in centrally planned economies like china chow 7 who helped pioneer the analysis of chinese macro data estimates a simple money demand function derived from the quantity theory using annual data from 1952 through 1983 he concludes that the quantity theory provides a reasonable first approximation in explaining the demand for money in china 7 325 portes and santorum 27 use real and nominal adjustment specifications and test for the homogeneity of money demand with respect to the price level and real income feltenstein and farhadian 11 estimate a money demand function based on cagan s 3 work and blejer et al 1 estimate an error correction model using data for only the 1980s both studies find that the demand for real balances is explained by real income and an opportunity cost measure

can we improve the perceived quality of economic forecasts a number of topics are discussed concerning how economic forecasts can be improved in quality or at least in presentation these include the following using 50 uncertainty intervals rather than 95 noting that even though forecasters use many different techniques they are all occasionally incorrect in the same direction that there is a tendency to underestimate changes that some expectations and recently available data are used insufficiently lagged forecasts errors can help compensate for structural breaks series that are more forecastable could be emphasized and that present methods of evaluating forecasts do not capture the useful properties of some methods compared to alternatives

idiosyncratic risk and the equity premium evidence from the consumer expenditure survey abstract this paper investigates whether uninsured idiosyncratic risk accounts for the equity premium following mankiw j financial econ 17 1986 211 the paper develops an equilibrium factor model in which risk premia depend on the covariance between an asset s return and certain moments of the cross sectional distribution for consumption growth cross sectional consumption factors are constructed using data from the consumer expenditure survey but they do not appear to be promising candidates for explaining the equity premium the cross sectional factors are weakly correlated with stock returns and generate equity premia of 2 percent or less for preference specifications with low degrees of risk aversion

dynamics of inflation in india a p star approach p star models have become increasingly popular in recent years in developed countries however data constraints have limited their applicability to the ldcs in this paper such a model is attempted for india using both annual and quarterly data for the period 1955 1995 it is found that velocity in india is trend stationary and using cointegration techniques it is then possible to develop a model to gauge inflationary pressures in the economy the model is well calibrated to data and in out of sample forecasts it significantly outperforms a seasonal arma benchmark model the velocity gap version of the model is particularly successful

the relevance of p star analysis to uk monetary policy recent articles have attempted to restore the use of a simple measure of the money supply as an indicator of future price levels p star and to reestablish a causal link from money to prices in this paper we argue that the p star approach is flawed it is certainly more complex than traditional monetarist approaches but the fundamental questions of causality are in no way either affected or resolved we argue that the p star relationship does not have a causal link with prices but rather the causality runs from prices to money we also find that there is some causality running from money to real income so that monetary conditions do seem to have some predictive power for future levels of activity copyright 1994 by royal economic society

error correction mechanisms the interface between economic theory and applied econometrics is often one of uneasy compromise with the pragmatic justification for many accepted procedures resting on a theoretical base this paper examines the surprisingly strong arguments that exist in terms of economic theory for the use of error correction mechanisms in the specification of short run dynamic adjustment a common heresy exists that while economic theory provides a detailed analysis of comparative static equilibria it can offer no guidance as to the appropriate specification of dynamic adjustment towards an equilibrium perhaps in consequence it is not uncommon to find examples where the necessary dynamic specification is achieved by tacking onto an existing equilibrium specification some relatively ad hoc short run adjustment scheme the intercession of stochastic arguments in this process is confused and critical implications are frequently ignored in practice but perhaps more importantly there will typically be no guarantee that the dynamic specification is consistent with the prescribed equilibrium consistency in this sense requires that the short run dynamic adjustment be directed by the perceived disequilibrium and that eventual convergence to the equilibrium position be ensured that two separate theoretical arguments co exist within the final specification is the root cause of many difficulties both theoretical and empirical this abstract was borrowed from another version of this item

modeling the demand for narrow money in the united kingdom and the united states abstract despite the importance of well specified empirical money demand functions for inference forecasting and policy problems in modeling have arisen concerning the economic theories of money demand the data institutional frameworks financial innovation and econometric implementation by developing constant data coherent m 1 demand equations for the u k and the u s we investigate these issues and explain such puzzles as missing money the great velocity decline and the recent explosion in m 1 the endogeneity of money the lucas critique and the non invertibility of our m 1 models are also discussed

testing heterogeneous agent models an alternative aggregation approach abstract starting from the cross sectional aggregation of marginal utilities rather than intertemporal marginal rates of substitution this paper develops a new heterogeneous agent pricing kernel a closed form version of the new kernel depends on changes in the cross sectional variance of log consumption rather than the variance of changes in log consumption as in constantinides and duffie 1996 asset pricing with heterogeneous consumers journal of political economy 104 219 237 we implement the new kernel on household consumption data from the consumer expenditure survey cex at monthly and quarterly horizons the new kernel reconciles the premium on u s equities with the consumption of asset holders for reasonable values of relative risk aversion the new kernel also fares better than kernels based on the aggregation of intertemporal marginal rates of substitution in explaining the cross sectional variation of risk premia on stocks and bonds portfolios mimicking changes in the cross sectional variance of log consumption for asset holders command significant negative sharpe ratios

money for nothing universal child care and maternal employment abstract the strong correlation between child care and maternal employment rates has led previous research to conclude that affordable and readily available child care is a driving force both of cross country differences in maternal employment and of its rapid growth over the last decades we analyze a staged expansion of subsidized child care in norway our precise and robust difference in differences estimates reveal that there is little if any causal effect of subsidized child care on maternal employment despite a strong correlation instead of increasing mothers labor supply the new subsidized child care mostly crowds out informal child care arrangements suggesting a significant net cost of the child care subsidies

inflation targeting as a monetary policy rule the purpose of the paper is to survey and discuss in ation targeting in the context of monetary policy rules the paper provides a general conceptual discussion of monetary policy rules attempts to clarify the essential characteristics of in ation targeting compares in ation targeting to other monetary policy rules and draws some conclusions for the monetary policy of the european system of central banks jel classi cation e42 e52

which commodity taxes should supplement the income tax the analysis takes as its point of departure a continuum of consumers economy in which an optimum income tax exists and is the only tax instrument in operation the welfare effects of introducing small excise taxes to supplement the income tax are then explored essential in this context are changes in the tax distortions of work incentives it is shown that a commodity should be taxed or subsidized depending on whether it is positively or negatively related to leisure in a sense which is precisely defined the results are related to earlier contributions to the literature on direct versus indirect taxation the history of debates on the proper roles of direct and indirect taxation goes back at least to the days of gladstone as well described by atkinson 1977 the prevailing political opinion of the balance between the two types of taxes has varied over time at present the swing in a number of european countries seems to be in favour of reforms towards tax systems which rely more heavily on indirect taxation and less on income taxation in view of this long economic political record it is not surprising that the choice between income tax and commodity taxes has also become an important subject in tax theory an early contribution to the understanding of this issue was corlett and hague 1953 54 their main model considers a three good economy containing leisure and two taxed commodities there is only one consumer or a population of identical consumers labour is the only source of income producer prices are fixed the government s revenue requirement is given the starting point of the analysis is a situation in which the two commodities are taxed at uniform rates the question which is analyzed is then how the government can raise welfare by slightly differentiating the tax rates the answer which is derived is that the consumer good which is the stronger substitute for labour complement with leisure should be taxed at

an augmented p star model of indian inflation abstractan augmented p star model is estimated and tested to identify the drivers of inflation in india the model includes monetary and non monetary factors demand pull and cost push factors and

an alternative approach to the american demand for money with a decade of evidence behind it the profession seems to have agreed on the fact that a structural break shifted the american demand for money shortly after 1973 it is difficult to pinpoint the source of the trouble precisely let alone to explain the event with an econometric model in their survey judd and scadding 1982 tentatively concluded that financial innovation is the source of the problem while this conclusion has not been universally accepted the instability of the money demand function is largely taken as a given stylized fact the primary goal of this article is to provide an alternative solution to the case of the missing money using the methods of hendry 1979 it should be stressed at the outset that as this paper deals with a problem in the applied literature it is unabashedly empirical in nature the paper attempts to explain an empirical difficulty without presenting a new theoretical model of money demand rather in the context of the standard transactions demand theory for narrow money a number of questions are analyzed with an atypical econometric model was there actually a shift or a series of shifts in the demand for money if not why have other investigators concluded that there was in fact a shift most importantly what function seems to be the most reasonable approximation to the data generation process during the period in question

prices as factors approximate aggregation with incomplete markets abstract recent developments in intertemporal asset pricing theory focus on two sets of fundamental determinants of asset returns models with complete markets emphasize aggregate variables such as per capita consumption such models have not performed well empirically models with incomplete markets emphasize disaggregate variables such as the distribution of wealth these models have shown empirical promise but their lack of parsimony has led many to question their usefulness indeed most empirical applications as well as the best practice in the financial industry ignore much of what theory has to say altogether practitioners favor factor models and in particular models in which asset returns serve as factors that explain other asset returns this paper attempts to rationalize these very different approaches we show that in an incomplete markets economy an economy in which the true pricing kernel is high dimensional and difficult to measure a low dimensional pricing kernel that depends on returns as in the capm or the apt can accurately price assets in this sense theory based on fundamentals admits an approximate aggregation that is consistent with practical application theory and practice therefore may not be as disparate as they might seem

effective tax rates in macroeconomics cross country estimates of tax rates on factor incomes and consumption abstract this paper proposes a method for computing tax rates using national accounts and revenue statistics using this method we construct time series of tax rates for large industrial countries the method identifies the revenue raised by different taxes at the general government level and defines aggregate measures of the corresponding tax bases this method yields estimates of effective tax rates on factor incomes and consumption consistent with the tax distortions faced by a representative agent in a general equilibrium framework these tax rates compare favorably with existing estimates of marginal tax rates and highlight important international differences in tax policy

the search for a stable money demand function a survey of the post 1973 literature phe question of whether the demnand function for money is stable is one of the most important recurring issues in the theory and application of macroeconomic policy what is being sought in a stable demand function is a set of necessary conditions for money to exert a predictable influence on the economy so that the central bank s control of the money supply can be a useful instrument of economic policy as such the notion of a stable demand function appears to involve three key elements e g john t boorman 1976 p 317 and david e w laidler 1977 pp 34 35 first the demand for money relation should be highly predictable in a statistical sense as measured by the usual goodness of fit statistics precision of estimated coefficients and presumably its ability to forecast accurately out of sample second a stable demand function for money has relatively few arguments a relationship that requires knowledge about a large number of variables in order to pin it down is in effect not predictable finally the variables that appear as arguments in the function should represent significant links to spending and economic activity in the real sector in sum a stable demand function for money means that the quantity of money is predictably related to a small set of key variables linking money to the real sector of the economy the importance of a stable money demand function for monetary policy can be illustrated with the standard is lm model in which interest rates and gnp are the endogenous variables in this context a stable demand function for money translates into a well defined relationship between money interest rates and gnp

the extensive macro labor supply elasticity integrating taxes and expenditures abstract this paper shows that accounting for certain public expenditures is crucial when comparing labor tax system efficiencies across countries to measure the extensive margin response to taxation i assemble a large cross country dataset consisting of the employment ratios the average effective tax rates the out of work benefits transfers as well as public expenditures on childcare elderly care and family policy covering all oecd countries and more than two decades when not controlling for the country and year fixed effects the extensive margin elasticities are negative once accounting for transfers the elasticities are negative or at most flat even with fixed effects once additionally accounting for public expenditures subsidies on labor complements which are robustly positively associated with the employment to population ratios i obtain either flat or positive extensive margin elasticities in the lower end of the expected range

inflation unemployment and duration abstract in tge earky 1990s core cpi inflation and employment cost inflation have been overpredicted by phillips curve models while the duration of unemployment has been unusually high duration adds significant information about core inflation in the post volcker disinflation period

the marginal cost of public funds hours of work versus labor force participation this paper extends the theory and measurement of the marginal cost of public funds mcf to account for labor force participation responses our work is motivated by the emerging consensus in the empirical literature that extensive participation responses are more important than intensive hours of work responses in the modelling of extensive responses we argue that it is crucial to account for the presence of non convexities created by fixed work costs in a non convex framework tax and transfer reforms give rise to discrete participation responses generating first order effects on government revenue these revenue effects make the marginal cost of funds higher and we show numerically that the implications for mcf tend to be substantial

should bond funds be added to m2 abstract in the early 1990s m2 growth has been weaker than estimated while bond mutual funds have grown rapidly this study assesses whether adding bond funds to m2 would yield a monetary aggregate that is more explainable using a standard error correction model of money with and without modifications for bond interest rate and thrift resolution effects results indicate that it is important to net out institutional and ira keogh assets from bond funds as is done for m2 and that adding such a bond fund series to m2 results in an aggregate that is somewhat more explainable than m2

the empirical foundations of the arbitrage pricing theory abstract this paper uses maximum likelihood factor analysis of large cross sections to examine the validity of the arbitrage pricing theory apt we are unable to explain the expected returns on firm size portfolios although we do explain the expected returns on portfolios formed on the basis of dividend yield and own variance where risk adjustment using the usual capm market proxies fails we also compare alternate versions of the apt and sharply reject the hypothesis that basis portfolios formed to mimic the factors span the mean variance frontier of the individual assets

money and inflation in the euro area a case for monetary indicators abstract this paper examines inflation indicators for the euro area by studying the relationship between inflation output money and interest rates using data spanning 1980 2001 the central finding is that both the output gap and the real money gap the difference between the real money stock and the long run equilibrium real money stock contain considerable information regarding future inflation in contrast the eurosystem s money growth indicator the difference between nominal money growth and a reference value the prominent first pillar in its monetary strategy contains little information about future inflation and no information beyond that contained in the output and real money gaps the predictive performance of the output gap has improved compared to that in a previous version of this paper most likely because of better estimation methods

welfare reform in european countries a microsimulation analysis this article compares the effects of increasing traditional welfare to introducing in work benefits in the 15 pre enlargement countries of the european union we use a labour supply model encompassing responses to taxes and transfers along both the intensive and extensive margins and the euromod microsimulation model to estimate current marginal and participation tax rates we quantify the equity efficiency trade off for a range of elasticity parameters in most countries because of large existing welfare programmes with high phase out rates increasing traditional welfare is undesirable unless the redistributive tastes of the government are extreme in contrast the in work benefit reform is desirable in a very wide set of cases

estimating potential output as a latent variable this article proposes a new method for estimating potential output in which potential real gross domestic product gdp is modeled as an unobserved stochastic trend and deviations of gdp from potential affect inflation through an aggregate supply relationship the output and inflation equations together form a bivariate unobserved components model which is estimated via maximum likelihood through the use of the kalman filter algorithm the procedure yields a measure of potential output and its standard error and an estimate of the quantitative response of inflation to real growth and the output gap

asset returns with transactions costs and uninsured individual risk abstract we explore whether incorporating an explicit motive for holding liquid assets within an equilibrium asset pricing model helps explain the following features of asset returns and turnover in the post war u s economy i the low risk free real interest rate ii the large spread between returns on liquid assets and stocks and iii the greater transaction velocity of liquid assets relative to stocks we introduce a demand for liquid assets by adding uninsured individual risk together with differential costs of trading securities numerical simulations attempting to match the return data generate a ratio of liquid assets to income considerably below observed levels

regression direction and weak exogeneity abstract the absence of testing for weak exogeneity in money demand has often led to stark conditioning claims regarding the validity of price equations this paper uses the johansen procedure to explore the conditioning properties of money demand systems for nonborrowed reserves m1 and m2 our results show that irrespective of the specification of the cointegrating relation a feedback mechanism enters the equation for money the opposite however is not true for the price equations the results also cast a warning for single equation models of money demand in that weak exogeneity is sensitive to how the system is defined

formation of inflation expectations from the simple to the rational expectations hypothesis using quarterly survey expectational data for seven ec countries this paper tests how producers form their inflation expectations the results indicate that the simple expectational hypotheses do not give an adequate account of the variation in the price expectational data because they fail to allow for the information contained in forecast models of inflation however the producers generally do not incorporate disequilibrium inflation into their inflation expectations

inflation and money in colombia another p star model this document presents the estimation of a recent version of the p star model by gerlach and svensson 2003 and its predictions for colombia january 1980 to april 2005 the model is designed to explain the inflation gap observed rate minus the target based on the monetary gap and the output gap according to the results the output gap lacks significant effects while the monetary gap has significant positive effects on inflation

policy regime changes and monetary expectations testing for super exogeneity abstract the super exogeneity status for weekly u s monetary expectations structure is examined the incomplete structure of the proposed model requires the use of an incidental parameter which is approximated by a linear function of certain instruments a super exogeneity test within the instrumental variables framework examines whether distributional changes stemming from the regime shifts affect the error correction parameter in the expectations structure under the assumption that the variance of the error correction term is constant the data evidence is found to reject super exogeneity

what makes the output inflation trade off change the absence of accelerating deflation in japan it is standard to model the output inflation trade off as a linear relationship with a time invariant slope we assess empirical evidence for two sets of theories that allow for endogenous variation in the slope of the short run phillips curve at an empirical level we examine why large negative output gaps in japan in the late 1990s did not lead to accelerating deflation but instead coincided with stable albeit moderately negative inflation our results suggest that this episode is most convincingly interpreted as reflecting a gradual flattening of the phillips curve we find that this flattening is best explained by models with endogenous price durations these models imply that in any economy where trend inflation is substantially lower or substantially higher today than in past decades time variation in the slope of the phillips curve has become too important to ignore

the long run link between money growth and inflation is inflation always a monetary phenomenon many economists believe that the link between money growth and inflation in the u s has weakened over the last two decades due in part to the federal reserve s policy experiment in 1979 1982 and innovations in the financial sector of the economy i find that the long run relationship between money growth and inflation is strong in a statistical sense and important economically the key result is that the trend or growth component in cpi inflation is entirely due to the trend component of monetary base growth jel c32 e31 e51

money growth output growth and inflation estimation of a modern quantity theory 1 introduction during the years 1980 1993 annual inflation averaged 81 5 in latin america 12 3 in africa but only 6 4 among 16 countries in the oecd within latin america inflation ranged from 8 2 in honduras to 374 3 in argentina and in africa from 0 6 in the republic of the congo to 61 6 in sierra leone what are the reasons for these large differences if cross country differences in inflation can be linked closely to corresponding differences in money growth the reason is clear but if the link is weak then other reasons must be sought several authors have recently rejected money growth as an explanation of inflation there are three lines of criticism the first typified by baba hendry and starr 1992 estrella and mishkin 1997 and cochrane 1998 argues that the income velocity of and thus the demand for monetary aggregates is so unstable that money growth is an unreliable explanation a second criticism closely related to the first is a time series issue if money the price level and output are not cointegrated then there is no stable long run relationship among them some researchers find evidence of cointegration hoffman and rasche 1991 baba hendry and starr 1992 stock and watson 1993 hoffman rasche and tieslau 1995 swanson 1998 carlson et al 2000 dutkowsky and atesoglu 2001 but others do not stock and watson 1989 hafer and jansen 1991 friedman and kuttner 1993 thoma 1994 the cointegration question remains unsettled a third criticism is quite distinct from the first two it argues that in dynamic general equilibrium models with infinitely lived households money in the household utility function and rational expectations there is a class of policy rules with a unique solution that shows that the price level is independent of monetary policy but dependent strictly on fiscal policy this fiscal theory of price level determination breaks any link between money growth and inflation the key fiscalist models were developed by leeper 1991 sims 1994 1996 and woodford 1994 1995 1998 a simple version is summarized succinctly by mccallum 2001 who demonstrates an alternative mathematical solution to a fiscalist model that yields a monetary explanation of the price level but the monetarist foundations are under vigorous attack 1 this paper specifies and estimates a modern version of the quantity theory of money growth real gdp growth and inflation its traditional feature is that a country s long run inflation rate increases with its money growth rate the modern wrinkle is that inflation is mitigated by real gdp growth i assume that real gdp growth is governed by exogenous forces such as growth in human capital physical capital formation and technological progress the model makes no attempt to explain gdp growth rates long run neutrality is presupposed i show that the quantity theory can be written as a regression model whose theoretical implications can easily be tested section 3 this paper then makes three empirical contributions the first is to estimate a long run version of the quantity theory and test its implications statistically sections 5 and 6 the estimates are long run in the important sense that inflation money growth and real gdp growth rates are annual averages computed for 81 countries over the 14 years from 1980 to 1993 short run changes in the series are excluded by design the second is to partition statistically the roles of money and real gdp growth as determinants of inflation section 7 the third is to conduct out of sample forecasts section 8 here we discover how well the model estimated for one group of countries predicts inflation in others this paper differs from previous work in three important ways first earlier research has not been based on theoretically grounded regression models friedman 1956 1968 klein 1956 friedman and friedman 1980 friedman and schwartz 1982 mccandless and weber 1995 rolnick and weber 1997

asset pricing puzzles and incomplete markets the representative agent theory of asset pricing is modified to incorporate heterogeneous agents and incomplete markets the model features two types of agents who differ up to a nontradable idiosyncratic component in their endowment processes numerical solutions indicate that individuals are able to diversify a substantial portion of their idiosyncratic income risk through riskless borrowing and lending alone restrictions on the variability of intertemporal marginal rates of substitution hansen and jagannathan 1991 are used to argue that incomplete markets as modeled here cannot account for the properties of asset returns that are anomalous from the perspective of representative agent theory a large literature in financial economics has investigated the extent to which variants of the lucas 1978 general equilibrium theory of asset pricing can account for the joint behavior of aggregate u s consumption and asset returns by and large this literature has concluded that a theory based upon frictionless arrow debreu markets and or a representative agent makes strongly counterfactual predictions regarding even the simple unconditional properties of this relationship mehra and prescott 1985 for instance show that the theory drastically underpredicts the average excess rate of return on u s stocks the so called equity premium puzzle weil 1989 points out as did mehra and prescott that the magnitude of the average risk free rate is far below that predicted by the theory this has been dubbed the risk free rate puzzle numerous authors including grossman melino and shiller 1987 and backus gregory and zin 1989 show that the theory cannot account for term premia inherent in the yield curve hodrick 1987 surveys a large literature which documents the theory s shortcomings in accounting for excess expected returns in foreign exchange markets the notion that the representative agent model cannot account for excess returns across a wide array of asset markets can be made more precise by using tools developed by hansen and jagannathan 1991 and shiller 1982

comparing labor supply elasticities in europe and the united states new results we suggest the first large scale international comparison of labor supply elasticities for 17 european countries and the united states using a harmonized empirical approach we find that own wage elasticities are relatively small and more uniform across countries than previously considered nonetheless such differences do exist and are found not to arise from different tax benefit systems wage hour levels or demographic compositions across countries suggesting genuine differences in work preferences across countries furthermore three other findings are consistent across countries the extensive margin dominates the intensive margin for singles this leads to larger responses in low income groups and income elasticities are extremely small

microfoundations and the demand for money the reader should note that i write this piece in a style that aims to be accessible to that much neglected representative agent the woman on the eurostar train hence unlike the man on the clapham omnibus i assume my intrepid traveller has reasonable knowledge of monetary economics and econometrics but not of the details of the demand for money space constraints force me to indulge in a certain amount of poetic licence but i hope this results in poetic justice there have been many wars fought on this particular battlefield some with almost religious zeal on the theoretical side of the debate we sometimes have the equivalent of religious fundamentalists be they muslims jews christians etc who would dismiss almost any evidence unless it were associated with a strong microtheoretic basis as laid down in the koran talmud or bible the empirical side encompasses agnostics atheists as well as born again econometricians pure theorists inhabit the sunlit uplands while applied economists and policymakers flounder in the muddy plain below occasionally gaining solace from their copy of zen and the art of motorcycle maintenance in general in economics we do not have the luxury of controlled experiments as is the case in the natural sciences what distinguishes good microfoundations from bad and how to weight priors and statistical evidence is subject to much dispute leamer i983 hendry et al i990 as in religion sometimes there is the occasional miracle proclaimed after a suitable interval a new saint may be declared and disciples flock to the new shrine later doubts may arise as to whether a miracle really did occur human behaviour is difficult to explain let alone predict so the search for the equivalent of the holy grail ark of the covenant etc is bound to be arduous in scholarly journals we generally read of the success of the demand for money like diplomats who are sent abroad to lie for the good of their country publication may require applied economists to be somewhat economical with the actualite lovell i983 leamer i983 in this article i want to be as honest as possible about our success and failures in this area the prior information an armchair economist would consider when thinking about the demand for money over the past 40 years in western industrialised countries which have experienced moderate inflation might

swedish tax rates labor supply and tax revenues effective marginal tax rates on labor income for the representative swede have increased from roughly 50 percent in 1959 to 80 percent today the effects of this increase in the level of taxation are examined using a two sector model parameterized to correspond to the swedish economy the model contains a single household which allocates labor to either taxed essentially market or untaxed largely household uses the estimated long run effects are sufficient to explain up to 75 percent of the recent decline in the measured growth rate of the swedish gnp calculations of total tax revenues are also derived from the model these peak when the tax rate is approximately 70 percent indicating that sweden is presently on the downward sloping portion of its laffer curve

monetary analysis and monetary policy in the euro area 1999 2006 abstract this paper assesses the practical experience of monetary analysis at the ecb from the introduction of the euro in 1999 through 2006 the paper exploits a unique and rich real time data set containing both the vintages of data and the economic models that have been employed in the ecb s monetary analysis during the first eight years of monetary union it embodies both a description of how monetary analysis was conducted over this period and a quantitative evaluation of the indicators of risks to price stability that derived from this analysis a close investigation of this material is used to evaluate the role monetary analysis has played in the evolution of monetary policy in the euro area

a general equilibrium model of changing risk premia theory and tests keywords asset pricing theory reference sfi pb article 1989 001doi 10 1093 rfs 2 4 467 record created on 2008 03 12 modified on 2017 05 12

estimating labour supply elasticities based on cross country micro data a bridge between micro and macro estimates the nordic model relies on high tax rates to finance an extensive welfare state if labour supply elasticities are large the burden of financing the model can be large even if arguably the practice of providing subsidised goods that support labour supply is likely to mitigate these effects we utilise repeated cross sections of micro data from several countries including the four major nordic countries available from the luxembourg income study lis to estimate labour supply elasticities both at the intensive and extensive margins the data span over four decades and include a large number of tax reform episodes with tax rate variation arising both from cross sectional and country level differences using these data we investigate whether micro and macro estimates differ in a systematic way the results do not provide strong support for the view that elasticities at the macro level would be higher than the corresponding micro elasticities

how can scandinavians tax so much american visitors to scandinavian countries are often puzzled by what they observe despite large income redistribution through distortionary taxes and transfers these are very high income countries they rank among the highest in the world in terms of income per capita as well as most other economic and social outcomes the economic and social success of scandinavia poses important questions for economics and for those arguing against large redistribution based on its supposedly detrimental effect on economic growth and welfare to form a basis for the discussion table 1 shows tax revenues and income tax rates in the three scandinavian countries denmark norway and sweden as compared to other european countries and the united states we see that the tax to gdp ratio and the tax rates on income are much higher in scandinavia than elsewhere the top marginal tax rates are about 60 70 percent in the scandinavian countries as opposed to only 43 percent in the united states the contrast is even more striking when considering the so called participation tax rate which is the effective average tax rate on labor force participation when accounting for the distortions due to income taxes payroll taxes consumption taxes and means tested transfers this tax rate is around 80 percent in the scandinavian countries implying that an average worker entering employment will be able to increase consumption by only 20 percent of earned income due to the combined effect of higher taxes and lower transfers by contrast the average worker in the united states gets to keep 63 percent of earnings when accounting for the full effect of the tax and

eurosystem monetary targeting lessons from u s data abstract using a small empirical model of inflation output and money estimated on u s data we compare the relative performance of monetary targeting and inflation targeting the results show monetary targeting to be quite inefficient yielding both higher inflation and output variability this is true even with a nonstochastic money demand formulation our results are also robust to using a p model of inflation therefore in these popular frameworks there is no support for the prominent role given to money growth in the eurosystem s monetary policy strategy

endogenous borrowing constraints with incomplete markets this article develops ways to endogenize the borrowing constraints used in a class of computable incomplete markets models we allow the constraints to depend on an investor s characteristics such as time preference risk aversion and income streams the proposed constraint can be interpreted as a borrowing limit within which an investor has no incentive to default using a numerical algorithm we find that for an array of structural parameters the endogenous borrowing constraints can be much less stringent than the ad hoc borrowing constraints adopted by the existing studies

money and velocity during financial crises from the great depression to the great recession abstract this study models the demand for a broad monetary aggregate m2 from the great depression through the great recession key to the model is the interaction between a measure of time variation in economic agents perceived financial risk and an index of the cost of portfolio adjustment the finding of a useful money demand relationship suggests that skepticism regarding the indicator role of a broad liquid money aggregate as a policy guide may be exaggerated further our model provides some guidance for policymakers who face the challenge of unwinding large balance sheets as risk premia return to normal and velocity adjusts

the information content of money in forecasting euro area inflation this article contributes to the debate on the role of money in monetary policy by analysing the information content of money in forecasting euro area inflation we compare the predictive performance within and among various classes of structural and empirical models in a consistent framework using bayesian and other estimation techniques we find that money contains relevant information for inflation in some model classes money based new keynesian dynamic stochastic general equilibrium dsge models and vector autoregressions vars incorporating money perform better than their cashless counterparts but there are also indications that the contribution of money has its limits the marginal contribution of money to forecasting accuracy is often small money adds little to dynamic factor models and it worsens forecasting accuracy of partial equilibrium models finally nonmonetary models dominate monetary models in an all out horserace

the value of time and recent u s money demand instability much controversy has surrounded the u s money demand relationship or more precisely its stability this is rather disappointing in light of the central importance of money demand estimates for the formulation and implementation of effective monetary policy and for almost all theories of aggregate economic activity to date the vast majority of alternative money demand specifications have generally failed to produce a stable money demand function throughout the 1970s and 1980s

can hysteresis explain different labour market operations between europe and the united states this paper offers an analysis of the labour market operation in europe and the united states during 1970 1985 it appears that the labour market developments in europe are more characterized by hysteresis than in the united states simulation results indicate that the unemployment rate in europe would have reached the level of that in the united states in 1985 when wage formation had been more similar

institutional hypothesis of the long run income velocity of money and parameter stability of the equilibrium relationship it has recently been argued that when the conventional specification of m2 income velocity is extended to include proxies for two types of institutional change as emphasized by bordo and jonung 1987 1990 corresponding to the processes of monetization and increasing financial sophistication of financial developments this extended model is stable in the sense that one can reject the null hypothesis of no cointegration against the alternative of a single cointegrating vector there may be implications that such an equilibrium relation is a structural income velocity of money function the evidence based on century long data from 1880 to 1986 presented in this paper about parameter instability of the cointegrating vector of velocity with its determinants for canada norway sweden and the united kingdom casts doubt on this interpretation the evidence is based on using formal stability tests moreover it has an eyeball support from the sequential estimates of various parameters of the cointegrating relationship including income and interest semi elasticities

the conduct of monetary policy nowadays the central bank of a country is the monopoly supplier of legal tender currency the commercial banks are committed to making their deposits convertible at par into such currency so the banks need to keep reserves in the form of currency and deposits at the central bank the central bank primarily conducts its policy by buying and selling financial securities e g treasury bills or foreign exchange in exchange for its own liabilities i e open market operations academic economists generally regard such operations as adjusting the quantitative volume of the banks reserve base and hence of the money stock with rates prices in such markets simultaneously determined by the interplay of demand and supply central bank practitioners almost always view themselves as unable to deny the banks the reserve base that the banking system requires and see themselves as setting the level of interest rates at which such reserve requirements are met with the quantity of money then simultaneously determined by the portfolio preferences of private sector banks and non banks this difference in perceptions is discussed again in section iii whether the monetary policy operations of central banks should be viewed primarily in terms of quantity or rate setting actions though of course one is the dual of the other these had allowed inflation and inflationary expectations to become entrenched by the end of the i970s a selection of representative statistics for a number of the leading industrialised countries is given in table i below this table indicates a common pattern among the countries of interaction between interest rates inflation and the growth of output the first period i969 78 is marked by high inflation negative real interest rates and slightly above average growth the second period i979 82 by very high nominal and high real interest rates high but falling inflation and very low output growth the final period i983 7 is marked by much lower inflation lower nominal but still high real interest rates and a recovery in output growth in some cases to above average rates in contrast the relationship in these countries between the growth of their chosen key monetary aggregate and nominal incomes appears much weaker also see clinton and chouraqui i987 especially p 7 whether measured in terms of monetary growth or in terms of real interest rates i e after adjustment for prospective future inflation policy during the

adding bond funds to m2 in the p star model of inflation abstract during the early 1990s m2 growth has been unusually weak and the p star model has underpredicted inflation at the same time bond funds have grown rapidly we find that the p star model performs well recently when m2 is adjusted for bond funds

quantitative asset pricing implications of endogenous solvency constraints we study the asset pricing implications of an economy where solvency constraints are endogenously determined to deter agents from defaulting while allowing as much risk sharing as possible we solve analytically for efficient allocations and for the corresponding asset prices portfolio holdings and solvency constraints for a simple example then we calibrate a more general model to u s aggregate as well as idiosyncratic income processes we find equity premia risk premia for long term bonds and sharpe ratios of magnitudes similar to the u s data for low risk aversion and a low time discount factor article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

money in an estimated business cycle model of the euro area this article examines the role of money in a small scale dynamic general equilibrium model of the euro zone estimated by maximum likelihood the model allows for both intertemporal and intratemporal non separability in preferences we find first that real balances do not affect the marginal utility of consumption second money demand shocks mainly help to forecast real balances while real shocks explain the bulk of price output and interest rates fluctuations third the calculation of the natural rate of interest reveals that the evolution of the interest rate is mostly accounted for by the real sources of fluctuations

the buffer stock notion in monetary economics not the least of harry johnson s contributions to our discipline was the series of survey papers on aspects of monetary economics which he produced during the 1960s and 1970s it is no exaggeration to say that the way in which the literature of monetary economics is organised even now follows the design which johnson first set out in 1962 and built on in the subsequent decade nevertheless the subject has not stood still and one of the more interesting developments of the last few years has involved the introduction of what has been variously described as the disequilibrium money shock absorber or as i prefer to call it the buffer stock notion into monetary economics the development of this line of thought was getting underway before johnson s untimely death much of it indeed under the auspices of his own research programme at the lse even so this did not happen early enough for the relevant ideas to be put in their proper niche by johnson himself and the buffer stock approach is not yet fully integrated into the mainstream of monetary economics much of the relevant literature is empirical concerned with modelling particular aspects of the monetary experience of specific countries hence it is fragmented and contains few papers which attempt a coherent account of just what this approach is and how it relates to other approaches to monetary analysis although essays by goodhart 1982a b and judd and scadding 1982a contain important discussions of these issues to the best of my knowledge only jonson 1976a and knoester 1979a have devoted entire papers solely to this central issue and these are relatively inaccessible and hence less widely known than they deserve to be in this lecture i shall attempt to give a brief account of the essentials of this approach first i shall sketch out its microeconomic background and then i shall discuss those theoretical characteristics which differentiate it from the neo austrian analysis of robert e lucas jr and his associates as well as from the conventional keynesian approach to monetary economics last but by no means least i shall argue that it yields simple theoretical insights into important empirical and policy related issues which are troublesome for alternative approaches in short my tribute to harry

m3 money demand and excess liquidity in the euro area recent empirical studies have found evidence of unstable long run money demand functions if recent data are used if the link between money balances and the macroeconomy is fragile the rationale of monetary aggregates in the ecb strategy has to be doubted in contrast we present a stable long run money demand relationship for m3 for the period 1983 2006 to obtain the result the short run homogeneity restriction between money and prices is relaxed and a break in the income elasticity of money demand after 2001 is taken into account measures of excess liquidity do not show significant inflation pressures

more evidence on the money output relationship i introduction the empirical relationship between money and real output continues to produce conflicting evidence stock and watson 1989 using monthly u s data for the period 1960 85 report that while actual money growth m1 does not granger cause the growth of industrial production its detrended component does krol and ohanian 1990 internationalize stock and watson s study and find that both actual and detrended ml growth granger cause output growth in the u k but that neither series affects output growth in japan canada and germany friedman and kuttner 1992a 1992b 1993 question the role of money in explaining output behavior they report 1993 that even though the stock watson specification is used simply updating the sample through 1990 yields the result that detrended m1 growth no longer explains output growth friedman and kuttner also argue that the commercial paper rate or the spread between the three month treasury bill and the commercial paper rate provides a better gauge for output s reaction to monetary policy changes replacing the treasury bill rate used by stock and watson with the commercial paper rate or the spread friedman and kuttner find that m1 growth has no marginal explanatory power over output a feature of recent investigations of the money output link is the general use of a var specification based on the presumption that the series are difference stationary e g feldstein and stock 1994 several recent studies however have questioned this presumption due to the low power of unit root tests dejong et al 1992 dejong 1992 dejong and whiteman 1991a 1991b and rudebusch 1993 these studies suggest that it is difficult to distinguish between difference stationary as the null and trend stationary as the alternative hypothesis given the uncertainty about the existence of a unit root in economic time series we re examine the money output relation by specifically considering the affect of assuming that the series are trend stationary or difference stationary such an investigation is important to determine if permanent temporary changes in money and other series create permanent temporary shifts in real output for example if real output and money contain a unit root i e they are best represented by the difference stationary model permanent money shocks may produce permanent shifts in output put another way permanent money shocks may have a long run impact because they affect the stochastic trend component of output and thus change the output level for all future horizons on the other hand if output and other series are represented by a trend stationary model fluctuations around a trend level of these series are stationary mean reverting under this model a transitory money shock may only have a short run impact on output as it quickly returns to its trend level to analyze the sensitivity of results to different stationarity assumptions used we estimate two var systems one system uses the log levels of the variables along with a deterministic time trend the other uses the log difference of the series and excludes the trend term the first system represents the trend stationary specification and the second one represents the difference stationary specification there is some evidence that the money output link may be sensitive to the presence of a deterministic trend term e g eichenbaum and singleton 1986 stock and watson 1989 even so our study provides a direct comparison based on identical data sets of the effects that the two different stationarity specifications have on the money output results while testing the robustness of the money output connection is our main focus we also provide some different perspectives on the debate one is to use both long and short term data sets most studies limit the analysis to quarterly data from the post 1960 era we study the link between money interest rates and output using annual data over the extended period 1915 1993

lessons on monetary policy from the 1980s t he half decade running from mid 1982 to mid 1987 was a pretty good era for u s monetary policy as these things go a sharp easing of policy beginning some time around midyear 1982 helped set in motion a recovery from the most severe business downturn the united states had experienced since the 1930s a downturn that tight monetary policy earlier on had deliberately brought about in order to slow the alarming acceleration of prices the recovery that ensued developed into a sustained expansion that continued without interruption through the end of 1987 thereby setting a new record for the longest recorded business expansion in u s peacetime experience a fiscal policy based on unprecedentedly large and continually growing structural budget deficits was a major factor underlying this record length expansion but at least monetary policy did not stand in the way just as importantly the severe 1981 82 recession served its intended purpose of substantially restoring price stability and even after five years of expansion inflation remained modest by recent historical standards at least as judged by these outcomes for the standard objectives of macroeconomic policy u s monetary policy was a distinct success during these years economists hoping to say something useful about monetary policy have had a tougher time the quantitative relationships connecting income and price movements to the growth of familiar monetary aggregates including especially the m1 measure of the money stock that had been the chief focus of monetary policy during 1979 82 utterly fell apart during this period moreover the collapse of these long standing

estimating long run economic equilibria with stochastic trends an asymptotic theory is provided to analyze a menu of currently existing estimators of cointegrated systems we study in detail the single equation ecm seecm approach of hendry our theoretical results lead to prescriptions for empirical work such as specifying seecm s nonlinearly and including lagged equilibrium relationships rather than lagged differences of the dependent variable as covariates simulations support these prescriptions and point to problems of overfitting not encountered in the semiparametric approach of phillips and hansen 1990

identification and estimation of money demand in most natural sciences physics chemistry biology theories are validated by controlled experiment however in other natural sciences astronomy meteorology and in most social sciences including economics the data are characteristically generated not by experiment but by measurement of uncontrolled systems in economics theories take the form of restrictions on the models assumed to generate the data and statistical methods replace experimental controls in testing these restrictions and here is the difficulty in economics particularly macroeconomics the theory used to derive tests ordinarily does not generate a complete specification of which variables are to be held constant when statistical tests are performed on the relation between the dependent variable and the independent variables of primary interest accordingly in such cases there will be a set of often very different candidate regression based tests each of which has equal status with the others since each is based on a different projection of the same underlying multivariate model except in the unlikely event that the explanatory variables are mutually orthogonal the conditional regression coefficients which generally form the basis for the test statistic will depend on the conditioning set we conclude from this that if a theory which does not generate a complete specification of the regression test is nonetheless to have testable implications these implications must be robust over the permissible alternative specifications if the restrictions indicated by the theory are satisfied in some projections but not in others that have an equal claim to represent implications of the theory one cannot conclude that the theory has been confirmed the fact that the observable implications of valid theories must obtain over a broad but usually incompletely specified set of regressions rather than for a single regression introduces a large and unavoidable element of imprecision into hypothesis testing in macroeconomics generally it appears to be appropriate to weaken the statistical criterion for rejecting theories consider for example the theory of money demand which will engage our attention in this paper the tobin baumol square root formula implies that the elasticity of money demand with respect to the interest rate is exactly one half but which interest rate should wealth be held constant inflation in view of such uncertainties it would be inappropriate to insist in a literal minded fashion on rejecting the tobin baumol model if in some regression the measured interest elasticity differed from one half by more than two standard deviations and only then obviously a more flexible approach is called for the practice has been to conclude that the statistical evidence is consistent with the tobin baumol model as long as the interest rate coefficient is negative if it is negative and significant or negative and insignificantly different from minus one half that would provide somewhat stronger confirmation but a positive coefficient particularly a significantly positive coefficient would be viewed as raising questions about the validity of the theory in macroeconomics generally as in the money demand application the typical response to specification uncertainty has been to regard a theory as supported if the signs of the estimated coefficients agree with those expected from theory and as disconfirmed otherwise there is no theoretical justification for this procedure but it seems to be a reasonable course to follow the point that economic theory ordinarily generates incompletely specified statistical university of california santa barbara we have received helpful comments from andrew abel robert clower michael darby robert engle stephen goldfeld david laidler edward leamer robert lucas frederic mishkin and edward prescott thomas hall provided able research assistance

financial innovation and monetary control the economic conjuncture of the 1970s and 1980s was extremely disturbed with high and volatile inflation interest and exchange rates this led the monetary authorities of most western coun tries to adopt monetary targets as a financial discipline to constrain inflationary pressures but this same conjuncture also encouraged the process of financial innovation which subsequently eroded the stability of the links between certain monetary aggregates and nominal incomes which had provided the empirical basis for such targetry thus in his recent book financial in novations and the money supply podolski 1986 argues that

inflation and monetary dynamics in the us a quantity theory approach in this article we investigate the long run link between inflation and money growth in the united states since 1960 a measure of the long run inflation trend is constructed which bears the interpreation of monetary inflation rate and is directly related to the excess nominal money growth process money growth less output growth as postulated by the quantity theory consistent with the memory characteristics of the series their fractional integration and cointegration properties are taken into account in empirical modelling the proposed measure is then compared with several existing measures of core inflation aimed at capturing long run inflation dynamics but unrelated to money growth the monetary long run inflation rate performs well in out of sample forecasting exercises especially over a 2 3 year horizon yielding valuable information to monetary policymakers