time consistent public policy in this paper we study how a benevolent government that cannot commit to future policy should trade off the costs and benefits of public expenditure we characterize and solve for markov perfect equilibria of the dynamic game between successive governments the characterization consists of an inter temporal first order condition a generalized euler equation for the government and we use it both to gain insight into the nature of the equilibrium and as a basis for computations for a calibrated economy we find that when the only tax base available to the government is capital income an inelastic source of funds at any point in time the government still refrains from taxing at confiscatory rates we also find that when the only tax base is labour income the markov equilibrium features less public expenditure and lower tax rates than the ramsey equilibrium

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

the federal funds rate and the channels of monetary transmission the authors show that the interest rate on federal funds is extremely informative about future movements of real macroeconomic variables then they argue that the reason for this forecasting success is that the funds rate sensitively records shocks to the supply of bank reserves that is the funds rate is a good indicator of monetary policy actions finally using innovations to the funds rate as a measure of changes in policy the authors present evidence consistent with the view that monetary policy works at least in part through credit i e bank loans as well as through money i e bank deposits copyright 1992 by american economic association

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

credible public policy abstract credible public policy is defined in a way that incorporates competitive equilibrium behavior for households and subgame perfect nash equilibrium behavior for the government it is shown that the set of all equilibrium outcome paths for credible policies can be constructed by using arguments analogous to those of abreu 1988 for repeated games the results are then extended to systems with state variables simple models of monetary policy and capital taxation are studied by way of example

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

us business credit sources demand deposits and the missing money abstract this study accounts for much of the missing money in the us through compensating balances business lending by banks affects demand deposit growth standard money demand models include variables that likely pick up income and interest rate effects on the transactions demand for demand deposits and on compensating balance requirements provided that bank lending to firms is stable however during the missing money period business shifted toward nonbank sources of short term credit causing a decline in compensating balances empirical finding support this hypothesis as a partial explanation for the missing money using the federal reserve board s demand deposit model

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

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

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

optimal fiscal policy in a business cycle model this paper develops the quantitative implications of optimal fiscal policy in a business cycle model in a stationary equilibrium the ex ante tax rate on capital income is approximately zero there is an equivalence class of ex post capital income tax rates and bond policies that support a given allocation within this class the optimal ex post capital tax rates can range from close to independently and identically distributed to close to a random walk the tax rate on labor income fluctuates very little and inherits the persistence properties of the exogenous shocks thus there is no presumption that optimal labor tax rates follow a random walk most of the welfare gains realized by switching from a tax system like that of the united states to the ramsey system come from an initial period of high taxation on capital income

financial innovation and the demand for liquid assets note introduction recent innovations in the banking and finance sector have caused great difficulties for the conduct of monetary policy shifts in monetary aggregates unexplained by interest rate behavior when there are financial innovations make it difficult for the monetary authorities either to use an asset demand function in the conduct of monetary policy or to distill information from the behavior of monetary aggregates while the monetary authorities may know the specific innovations they generally do not know how these innovations will affect particular aggregates clearly such knowledge is important and essential since then the monetary authorities can more accurately interpret growth rates of the monetary aggregates and reduce policy mistakes especially when the growth rates of various aggregates differ substantially and the authorities must determine which aggregate is more reflective of general monetary conditions hester 1981 freedman 1983 and pierce 1984 among others have documented and discussed many of the specific financial innovations for the united states and canada as outlined by pierce these innovations generally can be divided into three types i those innovations which have lowered transactions costs for asset purchases and sales ii the emergence of previously unavailable assets and iii those innovations which allow institutions to avoid reserve requirements hester has theoretically analyzed the last of these this paper focuses on the other types of innovations primarily the first transactions or transfer costs are an important aspect of asset demands since most near money assets possess approximately equivalent risk characteristics the two most important features of competing assets are return and liquidity liquidity can be defined as the cost of transfer to an acceptable means of payment over the last decade both relative and absolute transfer costs and thus liquidity have varied dramatically and have generally been reduced this has caused substitutions between assets and thus shifts in monetary aggregates unexplained by macroeconomic variables such as income and interest rates it is such unexplained shifts over the last decade which have caused concern over the appropriate definitions of monetary aggregates

the velocity of us m2 in the 1990s some further evidence this paper investigates the behaviour of m2 velocity in recent years with special emphasis on the post 1989 period unlike previous studies in this area m2 velocity is analysed in the context of a small vector autoregressive var model which includes income prices interest rates and money growth volatility the hypothesis of a structural shift in m2 velocity associated with the post 1989 period is rejected by the var model this suggests that the unusual behaviour of m2 velocity since 1989 may be traced to the variability in its determinants rather than to a shift in the process generating velocity variance decompositions indicate that real income and the short term opportunity cost of m2 are the most important determinants of m2 velocity the long term opportunity cost of m2 and the return on equities also have significant impacts on m2 velocity

optimal taxation without state contingent debt in an economy studied by lucas and stokey tax rates inherit the serial correlation structure of government expenditures belying barro s earlier result that taxes should be a random walk for any stochastic process of government expenditures to recover a version of barro s random walk tax smoothing outcome we modify lucas and stokey s economy to permit only risk free debt having only risk free debt confronts the ramsey planner with additional constraints on equilibrium allocations beyond one imposed by lucas and stokey s assumption of complete markets the ramsey outcome blends features of barro s model with lucas and stokey s in our model the contemporaneous effects of exogenous government expenditures on the government deficit and taxes resemble those in lucas and stokey s model but incomplete markets put a near unit root component into government debt and taxes an outcome like barro s however we show that without ad hoc limits on the government s asset holdings outcomes can diverge in importa

relational incentive contracts standard incentive theory models provide a rich framework for studying informational problems but assume that contracts can be perfectly enforced this paper studies the design of self enforced relational contracts i show that optimal contracts often can take a simple stationary form but that self enforcement restricts promised compensation and affects incentive provision with hidden information it may be optimal for an agent to supply the same inefficient effort regardless of cost conditions with moral hazard optimal contracts involve just two levels of compensation this is true even if performance measures are subjective in which case optimal contracts terminate following poor performance jel c73 d82 l14

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

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

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

optimal fiscal and monetary policy some recent results this paper studies the quantitative properties of fiscal and monetary policy in business cycle models in terms of fiscal policy optimal labor tax rates are virtually constant and optimal capital income tax rates are close to zero on average in terms of monetary policy the friedman rule is optimal nominal interest rates are zero and optimal monetary policy is activist in the sense that it responds to shocks to the economy

information revelation in relational contracts we explore subjective performance reviews in long term employment relationships we show that firms benefit from separating the task of evaluating the worker from the task of paying him the separation allows the reviewer to better manage the review process and can therefore reward the worker for his good performance with not only a good review contemporaneously but also a promise of better review in the future such reviews spread the reward for the worker s good performance across time and lower the firm s maximal temptation to renege on the reward the manner in which information is managed exhibits patterns consistent with a number of well documented biases in performance reviews

the behavior of money demand in the 1980s existing money demand functions did not predict the strength in m1 in the 1980s this strength derived from the combination of a change in the character of m 1 due to elnancial deregulation and the sharp fall in market rates that began in 1982 the public s m2 demand function however remains unaffected by the forces that altered the m1 demand function the character of the public s m 1 demand function changed with the legalization nationwide in january 1981 of the checkable deposits known as nows because nows pay explicit interest they are used by the public as an instrument for saving as well as for effecting transactions mehra 1986 the addition of nows to m1 therefore caused m1 to become more highly substitutible with the savings instruments included in the non ml component of m2 that is savings deposits small time deposits money market deposit accounts mmdas and money market mutual funds of noninstitutional investors mmmfs furthermore financial institutions move the rate paid on nows only sluggishly in response to changes in market rates in contrast the rates paid on small time deposits mmdas and mmmfs move promptly in response to changes in market rates consequently when market rates fell beginning in late summer 1982 the differential between the rates paid on the non ml components of m2 and on nows fell sharply the public then substituted out of the non ml components of m2 and into the nows in m1 these substitutions increased m1 de

optimal fiscal and monetary policy in an economy without capital abstract this paper is concerned with the structure and time consistency of optimal fiscal and monetary policy in an economy without capital in a dynamic context optimal taxation means distributing tax distortions over time in a welfare maximizing way for a barter economy our main finding is that with debt commitments of sufficiently rich maturity structure an optimal policy if one exists is time consistent in a monetary economy the idea of optimal taxation must be broadened to include an inflation tax and we find that time consistency does not carry over an optimal inflation tax requires commitment by rules in a sense that has no counterpart in the dynamic theory of ordinary excise taxes the reason time consistency fails in a monetary economy is that nominal assets should from a welfare maximizing point of view always be taxed away via an immediate inflation in a kind of capital levy this emerges as a new possibility when money is introduced into an economy without capital

optimal fiscal policy in a stochastic growth model although most neoclassical growth models focus on competitive equilibria which are pareto optimal and ignore the role of government recent works by romer 28 29 judd 20 baxter and king s and bizer and judd 7 have shown that government can be introduced into and suboptimal equilibria can be studied in these models as well their studies however are positive analyses of the effects of fiscal policy in competitive equilibria the purpose of this paper is to apply ramsey s 27 theory of optimal taxation to the normative study of fiscal policy in a stocastic growth model ramsey studied a static representative consumer economy with many goods in his formulation a government consumes a fixed amount of these goods which it purchases at market prices and finances by levying flat rate excise taxes prices and quantities are determined in a competitive equilibrium the government is benevolent and its objective is to choose the optimal tax rates to maximize the representative consumer s utility a number of economists among them kydland and prescott 23 barro 3 turnovsky and brock 31 and lucas and stockey 26 have noted that ramsey s formulation can be applied to dynamic economies with uncertainty if one reinterprets the goods in static problems as dated state contingent goods in this framework a fiscal policy is a rule which specifies state contingent tax rates and the amount of public debt issue in each date the optimal fiscal policy is defined as the one which leads to a quantity

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

multimarket contact and collusive behavior traditional analyses of industrial behavior typically link the exercise of market power in an industry to internalfeatures such as demand conditions concentration and barriers to entry nevertheless some economists have remained concerned that external factors such as contact across markets may also play a significant role in determining the level of competitiveness in any particular industry in this article we examine the effect of multimarket contact on the degree of cooperation that firms can sustain in settings of repeated competition we isolate conditions under which multimarket contact facilitates collusion and show that these collusive gains are achieved through modes of behavior that have been identified in previous empirical studies of multimarketfirms

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

multilateral contracting and the employment relationship this paper studies the structure of the employment relationship in organizations it investigates the trade off firms face between making commitments to their workforce as a whole multilateral relational contracts and making more limited commitments to individuals or smaller groups of employees bilateral relational contracts multilateral contracts bind the firm more strongly to implicit commitments improving motivation but are difficult to adjust in response to changes in the environment bilateral contracts make workforce changes easier to implement the framework helps to explain the use of relative performance evaluation why firms rely on temporary employees and the adoption of two tier workforces

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

multilateral interactions improve cooperation under random fluctuations abstract in an environment subject to random fluctuations when does an increase in the breadth of activities in which individuals interact together help foster collaboration on each activity we show that when players on average prefer to stick to a cooperative agreement rather than reneging by taking their privately optimal action then such an agreement can be approximated as equilibrium play in a sufficiently broad relationship this is in contrast to existing results showing that a cooperative agreement can be sustained only if players prefer to adhere to it in every state of the world we consider applications to favor exchange multimarket contact and relational contracts

limited liability and incentive contracting with multiple projects i examine a principal agent model with multiple projects where a risk neutral manager is protected by limited liability the analysis has several interesting implications i incentive problems are shown to be a natural source of economies of scope as combining multiple projects under the management of a single manager relaxes the limited liability constraint ii as a result managers may be overloaded with work and exert inefficiently high effort and iii the analysis has implications for the optimal allocation of projects to different managers copyright 2001 by the rand corporation

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

financial sector weakness and the m2 velocity puzzle i introduction there has been a long running debate over the usefulness of monetary aggregates as intermediate targets or information variables in the conduct of monetary policy in the mid1970s the missing money episode associated with m1 money demand was documented by goldfeld 1976 and judd and scadding 1982 passage of the depository institutions deregulation and monetary control act in 1980 and the garn st germain act in 1982 ushered in a period of financial deregulation including interest bearing checking accounts and money market deposit accounts these innovations affected depositor behavior to such an extent as to make m1 unreliable as a target or indicator of policy as a result research efforts focused on m2 demand with initial evidence of stable short run specifications for this aggregate as in small and porter 1989 this issue remains timely with the recent example of the european central bank debating whether to target a monetary aggregate or inflation in its implementation of monetary policy as svensson 1999 points out in the united states feldstein and stock 1994 argue that the federal reserve should use the m2 monetary aggregate as an intermediate target on the other hand a fair amount of work suggests that m2 is not reliable as either a target or an indicator of monetary policy friedman and kuttner 1992 show that by the early 1990s the relationship between m2 and gross domestic producct gdp had weakened and estrella and mishkin s 1997 work provides further support for this finding miyao 1996 presents evidence that a cointegrating m2 demand relationship broke down in the 1990s as the link between m2 and gdp deteriorated the forecasting ability of m2 money demand equations also suffered the difficulties in forecasting m2 spurred a number of publications examining whether the deterioration in the m2 equation s forecasting ability was temporary or whether more fundamental factors such as flaws in the construction of the m2 aggregate the opportunity cost or both were at work carlson and parrott 1991 and duca 1992 first argued that the existence of troubled thrifts and the length of time it took the resolution trust corporation to resolve the thrifts difficulties helped explain the weakness in m2 in particular duca found that the change in the volume of cumulated deposits at resolved thrift institutions accounted for a large part of the m2 weakness although he suggested his findings be viewed cautiously because of the short time period of the analysis in the same article as well as in one subsequent to it duca 1995 also examined whether some of the weakness in m2 reflected substitution by households away from m2 type deposits and into bond and equity mutual funds he found that adding a bond fund series to m2 reduced estimated m2 growth shortfalls orphanides et al 1994 carlson and keen 1996 feldstein and stock 1996 and mehra 1997 also present evidence that the unusual behavior of m2 was related to growth in stock and bond mutual funds koenig 1996a 1996b focused on the competitiveness problems of financial intermediaries in the face of tighter regulations and stricter capital standards he proposed an alternative strategy for empirically modeling m2 by altering the opportunity cost measure to include a long term treasury bond rate this addition substantially improved forecasts of m2 until 1995 when large prediction errors once again appear feinman and porter 1992 and mehra 1997 also attempted to explain recent m2 instability through alternative measures of the opportunity cost rather than refine the opportunity cost or redefine the m2 monetary aggregate carlson et al 2000b present consistent evidence of a cointegrating relationship through the 1990s between real m2 various scale measures and an opportunity cost measure this result is obtained after adjusting for periods of financial restructuring in the early 1990s characterized by a sharp increase in bond and equity funds and a steep decline in small time deposits

results of a study of the stability of cointegrating relations comprised of broad monetary aggregates abstract we find strong evidence of a stable money demand relationship for mzm and m2m through the 1990s though the m2 relation breaks down somewhere around 1990 evidence has been accumulating that the disturbance is well characterized as a permanent upward shift in m2 velocity which began around 1990 and was largely over by 1994 taken together our results support the hypothesis that households permanently reallocated a portion of their wealth from time deposits to mutual funds although this reallocation may have been induced by depository restructuring we argue that the substitution could be explained by appropriately measured opportunity cost

should fiscal policy be different in a non competitive framework abstract this paper studies if imperfections in the labor market justify a different fiscal policy we present a dynamic general equilibrium model with a ramsey planner deciding about public spending labor taxes and debt two different labor market setups are considered first we assume a competitive labor market and then we introduce a union with monopoly power both models reach the same conclusion as regards to the cyclical properties of the optimal policy it is not optimal to implement a countercyclical fiscal policy we also find that government spending should be larger under perfect competition these main results arise both under complete and incomplete markets for the debt

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

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

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

optimal taxation of capital income with imperfectly competitive product markets abstract we show that the steady state optimal tax on capital income can be negative positive or zero in a neoclassical growth model that allows for imperfectly competitive product markets the sign of the optimal tax rate depends crucially on 1 the degree of monopoly power 2 the extent to which monopoly profits can be taxed 3 the size of the depreciation allowance and 4 the magnitude of government expenditures for an empirically plausible set of parameters we find that the steady state optimal capital tax can range between 10 and 22

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

debt and deficit fluctuations and the structure of bond markets we analyse the implications of optimal taxation for the stochastic behaviour of debt we show that when a government pursues an optimal fiscal policy under complete markets the value of debt has the same or less persistence than other variables in the economy and it declines in response to shocks that cause the deficit to increase by contrast under incomplete markets debt shows more persistence than other variables and it increases in response to shocks that cause a higher deficit data for us government debt reveals diametrically opposite results from those of complete markets and is much more supportive of bond market incompleteness

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

are risky assets substitutes for monetary assets i introduction financial innovation over the past couple of decades has enhanced the liquidity of many financial assets particularly noncapital certain risky assets further financial assets previously not regarded as monetary assets such as mutual funds and particularly money market mutual funds now provide monetary services such as liquidity and transactions services l given the increased liquidity of such funds the question arises as to whether risky assets are substitutes for capital certain monetary assets if noncapital certain assets are indeed substitutes for capital certain assets and are also being used for transactions purposes then agents may be treating risky assets as money although this issue has been addressed in the united states in the context of the addition of bond funds to m2 by for example duca 1995 no such research has yet been conducted in the united kingdom including risky assets in the analysis contradicts the work of ando and shell 1975 spencer 1986 appendix i pp 184 93 and spencer 1994 broadly they argue that since some nonrisky assets provide monetary services and probability also liquidity individuals would not hold risky assets for these purposes 2 in contrast hicks 1935 states that falling transaction costs and rising wealth encourages individuals to increase the proportion of risky assets in portfolio holdings most studies generally assume that risky assets fail to provide significant monetary services and for example have been excluded from the asset demand analysis of barr and cuthbertson 1991a drake fleissig and swofford 1997 and money demand studies such as taylor 1987 belongia and chrystal 1991 drake and chrystal 1994 and drake 1996 alternatively barr and cuthbertson 1991b use only risky assets in their asset demand system analysis the degree of substitution between risky assets and capital certain assets is an empirical issue while noncapital certain risky assets mutual funds and other financial assets may well be becoming closer substitutes for what people are using as money they are in no way perfect substitutes for the highly liquid cash assets to evaluate the role of noncapital certain assets we construct a noncapital certain risky divisia aggregate consisting of equities government bonds and unit trusts the divisia index allows for less than perfect substitution between assets and weights component assets according to their differing degrees of moneyness which may vary over time due to many factors for example financial innovation see barnett 1980 this methodology has been widely applied to monetary aggregation and money demand studies in a number of countries as in belongia 1996 drake 1996 drake and chrystal 1997 and anderson jones and nesmith 1997 to determine whether risky assets are substitutes for capital certain assets we use two other divisia aggregates constructed from traditional measures of money the first of these is an aggregate of highly liquid zero yield cash assets given that the component assets all have zero own rates of return however divisia aggregation is equivalent in this case to simple summation the second aggregate is a divisia aggregate of interest bearing capital certain assets including risky assets complicates the analysis because the degree of risk aversion will affect the estimates of substitution between capital certain and noncapital certain assets thus we also analyze how different degrees of risk aversion affect the results the substitution relationship between assets is estimated from an asymptotically ideal model aim the choice of an aim is in line with the recommendation of barnett fisher and serletis 1992 that flexible systems of demand equations should be used that allow for nonlinear optimizing behavior by economic agents furthermore this paper can be seen as an extension of the recent application of this model to u

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

a new empirically weighted monetary aggregate for the united states i introduction this article uses an approach to long run econometric modeling proposed by pesaran et al 2001 hereafter pss to develop an empirically weighted broad monetary aggregate for the united states and to demonstrate the advantages of this type of aggregate from a monetary policy perspective in particular we examine the ability of this type of approach to deal with periods of significant financial innovation and money demand instability a key requirement for monetary aggregates to provide a useful role in guiding monetary policy is that they should be stably related to the objectives of policy such as inflation or nominal income growth in this context the united states has exhibited periodic evidence of significant money demand instability most notably these have been goldfeld s 1976 case of the missing m1 in 1973 74 and the missing m2 episode of the early 1990s feldstein and stock 1996 in both cases the aggregate in question experienced a significant velocity increase and as a consequence previously established and apparently stable money demand relationships began to seriously overpredict the growth in these aggregates the missing m1 episode in 1973 74 together with subsequent evidence that m2 was more predictable than m1 led many economists to use m2 as an indicator of nominal activity hence during the 1980s m2 became the primary intermediate target of monetary policy furthermore the primacy of m2 appeared to be well supported by the available empirical evidence feldstein and stock 1994 for example established that the rate of change of m2 was a statistically significant predictor of the rate of change of nominal gross domestic product gdp over the period 1959 92 furthermore m2 remained statistically significant when short term interest rates were added to the relationship subsequent research such as miyao 1996 and estrella and mishkin 1997 however cast doubt on the robustness of this result carlson et al 2000 p 34 for example summarize the current situation by arguing that the promising empirical conclusions of feldstein and stock 1994 that established predictive content for m2 in a vector error correction setting do not seem to find support in data that extend through the mid 1990s the key factor behind the breakdown in the m2 relation appears to have been the substitution away from time deposits and into mutual funds particularly stock and bond mutual funds in the low interest rate environment of the early 1990s although the definition of m2 has been expanded by the federal reserve in the past to include money market mutual funds mmmfs and money market deposit accounts mmdas for example a number of analysts duca 1995 darin and hetzel 1994 orphanides et al 1994 have advocated that m2 should be expanded further to include these stock and bond mutual funds m2 significantly these studies typically use the simple sum aggregation approach in which all component assets are given equal and constant weights over time this approach does not seem consistent however with the accumulating evidence of a significant shift in wealth holders preferences sometime in the early 1990s carlson et al 2000 for example add to the empirical evidence that had accumulated during the 1990s by suggesting that the instability was associated with a permanent upward shift in m2 velocity between 1990 and 1994 furthermore they argue that our results support the hypothesis that households permanently reallocated a portion of their wealth from time deposits to mutual funds p 381 clearly simple sum aggregation is not able to take account of these changes in preferences more significantly however simple sum aggregation cannot take account of any changes in the relationship between component assets and nominal income over time although carlson et al 2000 do manage to reestablish a stable money demand relationship for the mzm money at zero maturity and m2m m2 minus small time deposits aggregates through the 1990s this is only possible by specifically accounting for the financial innovation that occurred in the early 1990s