limited commitment and the demand for money understanding money demand is important for our comprehension of macroeconomics and monetary policy its instability has made this a challenge common explications for the instability are financial regulations and financial innovations that shift the money demand function we provide a complementary view by showing that a model where borrowers have limited commitment can significantly improve the fit between the theoretical money demand function and the data limited commitment can also explain why the ratio of credit to m1 is currently so low despite that nominal interest rates are at their lowest recorded levels this article is protected by copyright all rights reserved

the american business cycle continuity and change in recent decades the american economy has experienced the worst peace time inflation in its history and the highest unemployment rate since the great depression these circumstances have prompted renewed interest in the concept of business cycles which joseph schumpeter suggested are like the beat of the heart of the essence of the organism that displays them in the american business cycle some of the most prominent macroeconomics in the united states focuses on the questions to what extent are business cycles propelled by external shocks how have post 1946 cycles differed from earlier cycles and what are the major factors that contribute to business cycles they extend their investigation in some areas as far back as 1875 to afford a deeper understanding of both economic history and the most recent economic fluctuations seven papers address specific aspects of economic activity consumption investment inventory change fiscal policy monetary behavior open economy and the labor market five papers focus on aggregate economic activity in a number of cases the papers present findings that challenge widely accepted models and assumptions in addition to its substantive findings the american business cycle includes an appendix containing both the first published history of the nber business cycle dating chronology and many previously unpublished historical data series

money at low frequencies many central banks have abandoned monetary targeting because the link between money growth and inflation seemed to disappear in the 1980s using spectral regression techniques we show that for the euro area japan the uk and the us there is a unit relationship between money growth and inflation at low frequencies when the impact of interest rate changes on money demand is accounted for we estimate phillips curve equations in which the low frequency information from money growth is combined with high frequency information from the output gap to explain movements in inflation jel c22 e3

approval voting borda winners and condorcet winners evidence from seven elections we analyze 10 three candidate elections and mock elections conducted under approval voting av using a method developed by falmagne and regenwetter 1996 that allows us to construct a distribution of rank orders from subset choice data the elections were held by the institute of management science the mathematical association of america several professional organizations in britain and the institute of electrical and electronics engineers seven of the 10 elections satisfy the conditions under which the falmagne regenwetter method is suitable for these elections we recreate possible underlying preferences of the electorate on the basis of these distributions of preferences we find strong evidence that av would have selected condorcet winners when they exist and would have always selected the borda winner thus we find that av is not just simple to use but also gives rise to outcomes that well reflect voter preferences our results also have an important implication for the general study of social choice processes they suggest that transitive majority orderings may be expected in real world settings more often then the formal social choice literature suggests in six out of seven data sets we find social welfare orders only one data set generates cycles anywhere in the solution space

is there a role for monetary aggregates in the conduct of monetary policy abstract we examine the potential policy role of monetary aggregates by attempting to use them as effectively as possible in the analysis of empirical relationships we focus on their role as information variables since any more ambitious use such as in a policy rule would presuppose some information content in the aggregates our results show that in the united states since 1979 the monetary aggregates fall considerably short of those requirements and results with german m3 are hardly more favorable we also investigate whether empirical relationships are not reflective of information relationships because of the use of these variables in countercyclical policy the results are not consistent with that interpretation

sophisticated monetary policies in standard monetary policy approaches interest rate rules often produce indeterminacy a sophisticated policy approach does not sophisticated policies depend on the history of private actions government policies and exogenous events and can differ on and off the equilibrium path they can uniquely implement any desired competitive equilibrium when interest rates are used along the equilibrium path implementation requires regime switching these results are robust to imperfect information our results imply that the taylor principle is neither necessary nor sufficient for unique implementation they also provide a direction for empirical work on monetary policy rules and determinacy

inflation and welfare in a monetary economy it is in everyone s private interest to try to get someone else to hold non interest bearing cash and reserves but someone has to hold it all so these efforts must simply cancel out all of us spend several hours per year in this effort and employ thousands of talented and highly trained people to help us these person hours are simply thrown away wasted on a task that should not have to be performed at all

unemployment and productivity in the long run the role of macroeconomic volatility abstract this paper presents a new empirical regularity between the volatility of productivity growth and long run unemployment for a given level of long run productivity growth a theoretical framework based on asymmetric real wage rigidities is shown to have the potential to rationalize this finding the model tends to fit u s long run unemployment better than a specification based on long run productivity growth only especially during the great moderation and the great recession

money income prices and interest rates including data from the 1980s sharply weakens the postwar time series evidence indicating significant relationships between money however defined and nominal income or between money and either real income or prices separately focusing on data from 1970 onward destroys this evidence altogether evidence indicating cointegration of real income and real money balances with due allowance for the effect of interest rates also deteriorates when the sample extends through the 1980s a positive finding is that the spread between the commercial paper rate and the treasury bill rate consistently contains highly significant information about future movements in real income copyright 1992 by american economic association

on the low frequency relationship between public deficits and inflation summary we estimate the low frequency relationship between fiscal deficits and inflation and pay special attention to its potential time variation by estimating a time varying vector autoregression model for us data from 1900 to 2011 we find the strongest relationship neither in times of crisis nor in times of high public deficits but from the mid 1960s up to 1980 employing a structural decomposition of the low frequency relationship and further narrative evidence we interpret our results such that the low frequency relationship between fiscal deficits and inflation is strongly related to the conduct of monetary policy and its interaction with fiscal policy after world war ii copyright 2015 john wiley sons ltd

is quantity theory still alive this paper investigates whether the quantity theory of money is still alive we argue that it is but that the slippage is not negligible for countries with low inflation the relationship between average inflation and the growth rate of money is tenuous at best a correction for variation in output growth and the opportunity cost of money using theory implied elasticities helps explain the slippage for the period since 1990 inflation targeting at low rates of inflation makes it harder to establish the long run relationship between monetary growth and inflation

does a cointegrating m2 demand relation really exist in the united states this paper reexamines evidence on m2 demand cointegration in the postwar united states equilibrium relations between m2 and various sets of its determinants are analyzed using quarterly observations from 1959 1 to 1988 4 1990 4 and 1993 4 based on three different testing methods for earlier subsamples mixed results are obtained suggesting both cointegration and no cointegration for the full sample however virtually no evidence supports cointegration accordingly a m2 error correction model is no longer appropriate to investigate short run dynamics of business fluctuations in the 1990s copyright 1996 by ohio state university press

the behavior of money and other economic variables two natural experiments abstract the object of this paper is to test the performance of the quantity theory model and the related proposition of monetary neutrality in a context in which to use bernanke s phraseology money move d for reasons that were plausibly unrelated to the current state of the economy we investigate this question using data from two recent episodes of monetary policy regime change the move to floating exchange rates throughout the industrialized world following the breakdown of bretton woods in the early 1970s and the shift toward less expansive monetary policy that to varying degrees took place in these countries a decade or so later the results of this exercise are highly positive the money price relationship that we observe is fully consistent with theory growth shifts in the nominal stock of money and in the price level are highly correlated and bear a one to one relation to one another growth shifts in exchange rates are significantly related both to growth shifts in relative price levels and to growth shifts in relative excess supplies of money the classical neutrality proposition in this context superneutrality in general receives strong though not totally unambiguous support

weak condorcet winner s revisited a strong condorcet winner scw is an alternative x that a majority of voters rank higher than z for every other alternative z a weak condorcet winner wcw is an alternative y that no majority of voters rank below any other alternative z but is not a scw there has been some confusion in the voting social choice literature as to whether particular voting rules that are scw consistent are also wcw consistent the purpose of this paper is to revisit this issue clear up the confusion that has developed and determine whether three additional scw consistent voting rules that as far as we know have not been investigated to date regarding their possible wcw consistency are indeed wcw consistent

financial innovation and the transactions demand for cash we document cash management patterns for households that are at odds with the predictions of deterministic inventory models that abstract from precautionary motives we extend the baumol tobin cash inventory model to a dynamic environment that allows for the possibility of withdrawing cash at random times at a low cost this modification introduces a precautionary motive for holding cash and naturally captures developments in withdrawal technology such as the increasing diffusion of bank branches and atm terminals we characterize the solution of the model which qualitatively reproduces several empirical patterns we estimate the structural parameters using micro data and show that quantitatively the model captures important economic patterns the estimates are used to quantify the expenditure and interest rate elasticity of money demand the impact of financial innovation on money demand the welfare cost of inflation and the benefit of atm ownership

testing for indeterminacy an application to u s monetary policy reply this paper considers a prototypical new keynesian model in which the equilibrium is undetermined if monetary policy is passive the likelihood based estimation of dynamic equilibrium models is extended to allow for indeterminacies and sunspot fluctuations we construct posterior weights for the determinacy and indeterminacy region of the parameter space and estimates for the propagation of fundamental and sunspot shocks according to the estimated model u s monetary policy post 1982 is consistent with determinacy whereas the pre volcker policy is not we find that before 1979 indeterminacy substantially altered the propagation of shocks

monetary fiscal policy interaction and fiscal inflation a tale of three countries abstract we study the impact of the interaction between fiscal and monetary policy on the low frequency relationship between the fiscal stance and inflation using cross country data from 1965 to 1999 in a first step we contrast the monetary fiscal narrative for germany the u s and italy with evidence obtained from simple regression models and a time varying var we find that the low frequency relationship between the fiscal stance and inflation is low during periods of an independent central bank and responsible fiscal policy and more pronounced in times of non responsible fiscal policy and accommodative monetary authorities in a second step we use an estimated dsge model to interpret the low frequency measure structurally and to illustrate the mechanisms through which fiscal actions affect inflation in the long run the findings from the dsge model suggest that switches in the monetary fiscal policy interaction and accompanying variations in the propagation of structural shocks can well account for changes in the low frequency relationship between the fiscal stance and inflation

time aggregation and the relationship between inflation and money growth using panel data for 99 countries we confirm that the measured elasticity of prices with respect to money is higher and closer to unity the higher is money growth and the longer the time horizon over which the data are averaged we propose two explanations in one the true model of inflation involves a lagged response to money growth in the other there is negative correlation between shocks to inflation and money growth our empirical results can be explained if high money growth countries have i shorter lags or ii less negative correlation when compared to countries with low money growth

on the sources of macroeconomic stability in the euro area in the mid 1990s the euro area experienced a change in macroeconomic volatility around the same time at business cycle frequencies the correlation between inflation and money growth changed markedly turning from positive to negative distinguishing the periods pre and post 1994 we estimate a dynamic stochastic general equilibrium model with money for the euro area the model accounts for the salient facts we then perform several counterfactual exercises to assess the drivers of these phenomena the moderation of real variables was essentially due to relatively smaller shocks to investment wage markups and preferences the apparent lack of evidence for the quantity theory of money in the short run and the changes in the volatility of nominal variables resulted primarily from a more anti inflationary and gradual monetary policy

on low frequency estimates of long run relationships in macroeconomics abstract a number of recent studies have attempted to test propositions concerning long run economic relationships by means of frequency domain time series techniques that concentrate attention on low frequency comovements of variables the present paper emphasizes that many of these propositions involve expectational relationships that are not inherently related to specific frequencies or periodicities thus the association of low frequency time series test statistics with long run economic propositions is not generally warranted that such an association can be misleading is demonstrated by analysis of examples taken from notable papers by geweke lucas and summers

delphic and odyssean monetary policy shocks evidence from the euro area abstract what drives the reaction of financial markets to central bank communication on the days of policy decisions we highlight the role of two factors that we identify from high frequency monetary surprises news on future macroeconomic conditions delphic shocks and news on future monetary policy shocks odyssean shocks these two shocks move the yield curve in the same direction but have opposite effects on financial conditions and macroeconomic expectations they also have a different impact on macroeconomic outcomes so that central bankers cannot infer the degree of stimulus they provide by looking at the mere reaction of the yield curve

another look at long run money demand abstract this paper investigates the long run demand for m1 in the postwar united states previous studies based on data ending in the late 1980s are inconclusive about the parameters of postwar money demand this paper obtains precise estimates of these parameters by extending the data through 1996 the income elasticity of money demand is approximately 0 5 and the interest semi elasticity is approximately 0 05 these parameters are significantly smaller in absolute value than the corresponding parameters for the prewar period a caveat is that the analysis assumes there is no trend in money demand resulting from technological change

the demand for money financial innovation and the welfare cost of inflation an analysis with household data we use microeconomic data on households to estimate the parameters of the demand for currency derived from a generalized baumol tobin model our data set contains information on average currency deposits and other interest bearing assets the number of trips to the bank the size of withdrawals and ownership and use of atm cards we model the demand for currency accounting for adoption of new transaction technologies and the decision to hold interest bearing assets the interest rate and expenditure flow elasticities of the demand for currency are close to the theoretical values implied by standard inventory models however we find significant differences between individuals with an atm card and those without the estimates of the demand for currency allow us to calculate a measure of the welfare cost of inflation analogous to bailey s triangle but based on a rigorous microeconometric framework the welfare cost of inflation varies considerably within the population but never turns out to be very lar

optimal voting rules modern social choice theory following kenneth arrow treats voting as a method for aggregating diverse preferences and values an earlier view initiated by marquis de condorcet is that voting is a method for aggregating information voters opinions differ because they make errors of judgment absent these errors they would all agree on the best choice the goal is to design a voting rule that identifies the best choice with highest probability this paper examines maximum likelihood estimation surprisingly the optimal rule can also be axiomatized by variations of arrow s axioms

policy language and information effects in the early days of federal reserve forward guidance i show that the nature of the federal open market committee s fomc s forward guidance language shapes the private sector s responses to monetary policy statements from february 2000 to june 2003 the fomc only gave forward guidance about economic outlook risks and a decrease in the expected federal funds rate path caused stock prices to fall gdp growth forecasts to fall and the unemployment rate to rise from august 2003 to may 2006 the fomc added forward guidance about policy inclinations and a decrease in the expected federal funds rate path had the opposite effects these results suggest that forward guidance that emphasizes economic outlook risks causes stronger information effects than forward guidance that emphasizes policy inclinations

on the instability of long run money demand and the welfare cost of inflation in the united states we evaluate the policy implications of measuring the welfare cost of inflation accounting for instabilities in the long run money demand for the u s over the period 1900 2013 we extend the analysis and reassess the results reported in lucas 2000 and ireland 2009 also considering the recent theoretical contributions of lucas and nicolini 2015 and berentsen et al 2015 breaks in the long run money demand give rise to regime dependent welfare cost estimates we find that the welfare cost is about 0 1 of annual income over 1976 2013 as compared to 0 8 over 1945 1975 overall these values are substantially lower than those reported in the literature

stochastic trends and economic fluctuations are business cycles mainly the result of permanent shocks to productivity this paper uses a long run restriction implied by a large class of real business cycle models identifying permanent productivity shocks as shocks to the common stochastic trend in output consumption and investment to provide new evidence on this question econometric tests indicate that this common stochastic trend cointegration implication is consistent with postwar u s data however in systems with nominal variables the estimates of this common stochastic trend indicate that permanent productivity shocks typically explain less than half of the business cycle variability in output consumption and investment copyright 1991 by american economic association

technology shocks in the new keynesian model in the new keynesian model preference cost push and monetary shocks all compete with the real business cycle model s technology shock in driving aggregate fluctuations a version of this model estimated via maximum likelihood points to these other shocks as being more important for explaining the behavior of output inflation and interest rates in the postwar u s data these results weaken the links between the current generation of new keynesian models and the real business cycle models from which they were originally derived they also suggest that federal reserve officials have often faced difficult trade offs in conducting monetary policy

an assessment of voting system simulations in applying the results of the social choice theory to voting procedures the question arises as to how often the various anomalies can be expected to occur computer simulations and probability modelling are common approaches to address this problem this article is an attempt to find out the robustness of the so called impartial culture assumption for this purpose first a major perturbation of the impartial culture assumption is considered and thereafter we focus on a few minor modifications of the assumption

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

a monetarist model of inflation abstract we consider an overlapping generations model with new money introduced via autocorrelated lump sum transfers hence the own rate of return on money is fixed implying that dynamic neutrality may fail due to inflation tax effects we derive a condition less restrictive than serial independence of monetary growth rates which is necessary as well as sufficient for neutrality we determine whether various properties of the joint distribution of monetary growth rates and inflation rates which are weaker than neutrality for example positive correlation between the two can be expected to obtain in general settings

central bank communication and monetary policy a survey of theory and evidence over the last two decades communication has become an increasingly important aspect of monetary policy these real world developments have spawned a huge new scholarly literature on central bank communication mostly empirical and almost all of it written in this decade we survey this ever growing literature the evidence suggests that communication can be an important and powerful part of the central bank s toolkit since it has the ability to move financial markets to enhance the predictability of monetary policy decisions and potentially to help achieve central banks macroeconomic objectives however the large variation in communication strategies across central banks suggests that a consensus has yet to emerge on what constitutes an optimal communication strategy

long run income and interest elasticities of money demand in the united states econometric techniques designed to accommodate nonstationary data are used to reexamine the stability of interest and income elasticities of money demand in the united states estimates based on postwar monthly data reveal a stable relationship between m1 velocity and various measures of interest rates that proxy the opportunity cost of holding money balances tests for the existence of cointegration and methods used to estimate the income and interest elasticities are based on procedures prescribed by soren johansen 1988 corresponding error correction estimates offer insight as to the dynamics of the process that maintains the equilibrium relation between velocity and interest rates copyright 1991 by mit press

what does monetary policy do to long term interest rates at the zero lower bound this article uses a structural var with daily data to identify the effects of monetary policy shocks on various longer term interest rates since the federal funds rate has been stuck at the zero lower bound the var is identified using the assumption that monetary policy shocks are heteroskedastic monetary policy shocks have especially high variance on days of fomc meetings and certain speeches while there is otherwise nothing unusual about these days a complementary high frequency event study approach is also used i find that stimulative monetary policy shocks lower treasury and corporate bond yields but the effects die off fairly fast

a note on nanson s rule e j nanson in 1883 proposed a voting rule designed mainly to select the condorcet winner unfortunately much of the collective choice literature has misstated nanson s rule this note shows that the misstated versions of the rule and nanson s actual rule can yield different outcomes and it provides a counter example which shows that nanson s rule although it satisfies the strong condorcet condition does not satisfy the weak condorcet condition

on the welfare cost of inflation and the recent behavior of money demand post 1980 u s data trace out a stable long run money demand relationship of cagan s semi log form between the m1 income ratio and the nominal interest rate with an interest semi elasticity of 1 79 integrating under this money demand curve yields estimates of the welfare cost of modest departures from friedman s zero nominal interest rate rule for the optimum quantity of money that are quite small the results suggest that the federal reserve s current policy which generates low but still positive rates of inflation provides an adequate approximation in welfare terms to the alternative of moving all the way to the friedman rule jel e31 e41 e52

a century of inflation forecasts abstract we investigate inflation predictability in the united states across the monetary regimes of the twentieth century the forecasts based on money growth and output growth were significantly more accurate than the forecasts based on past inflation only during the regimes associated with neither a clear nominal anchor nor a credible commitment to fight inflation these include the years from the outbreak of world war ii in 1939 to the implementation of the bretton woods agreements in 1951 and from nixon s closure of the gold window in 1971 to the end of volcker s disinflation in 1983

does the euro follow the german mark evidence from the monetary model of the exchange rate abstract this paper investigates whether german or synthetic european pre emu data provides the appropriate empirical basis for evaluating euro dollar exchange rate behavior monetary exchange rate equations are estimated for both data sets over the pre emu period and out of sample forecasts are evaluated to assess their ability to explain the euro dollar exchange rate from 1999 to 2004 while forecast accuracy tests confirm the usefulness of synthetic european data for euro exchange rate analysis forecasts based on the german pre emu experience cannot even beat a random walk our results indicate that the euro does not simply follow the german mark but that it has its origins in the other pre emu currencies as well

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

euro area money demand and international portfolio allocation a contribution to assessing risks to price stability this chapter argues that a stable broad money demand for the euro area over the period 1980 2011 can be obtained by modelling cross border international portfolio allocation we first observe that in this first decade of the new millennium the breakdown of standard money demand specifications for the euro area and the strong developments in annual m3 growth coincide with large net flows in portfolio invest ment in the euro area we then estimate a new money demand which turns out to be stable by including variables explaining portfolio flows omitted in the traditional specifications

the perils of taylor rules abstract since john taylor s 1993 carnegie rochester conf ser publ policy39 195 214 seminal paper a large literature has argued that active interest rate feedback rules that is rules that respond to increases in inflation with a more than one for one increase in the nominal interest rate are stabilizing in this paper we argue that once the zero bound on nominal interest rates is taken into account active interest rate feedback rules can easily lead to unexpected consequences specifically we show that even if the steady state at which monetary policy is active is locally the unique equilibrium typically there exist an infinite number of equilibrium trajectories originating arbitrarily close to that steady state that converge to a liquidity trap that is a steady state in which the nominal interest rate is near zero and inflation is possibly negative journal of economic literature classification numbers e52 e31 e63

stability of money demand function revisited in china as china s economic reforms have undergone significant structural changes after 1979 it has been rather difficult to formulate a stable money demand function over the period following that year while previous literature on the long run relationship of money demand in china shows the existence of stable money demand this article revisits the stability of the china money demand function over the period after 1979 to employ the unit root tests and the cointegration tests with structural break the empirical evidence demonstrates that economic and financial deregulation did affect the stability of demand for money in china over the period 1977 to 2002 moreover the estimated long run income and interest elasticity are respectively 1 01 1 11 and 0 14 0 08 using the real m1 m2 equation in addition real income and the interest rate are found to be weakly exogenous we overall do find structural breakpoints mainly in 1980 and 1993 and they look to match clearly with corresponding critical financia

monetary policy surprises and interest rates evidence from the fed funds futures market abstract this paper estimates the impact of monetary policy actions on bill note and bond yields using data from the futures market for federal funds to separate changes in the target funds rate into anticipated and unanticipated components interest rates response to anticipated target rate changes is small while their response to unanticipated changes is large and highly significant these responses are generally consistent with the expectations hypothesis of the term structure surprise target rate changes have little effect on expectations of future actions however which helps to explain the lack of empirical support for the expectations hypothesis at the short end of the yield curve

nonlinear equilibrium correction in u s real money balances 1869 1997 several theoretical models of money demand imply nonlinear functional forms for the aggregate demand for money characterized by smooth adjustment toward long run equilibrium in this paper we propose a nonlinear equilibrium correction model of u s money demand that is shown to be stable over the sample period from 1869 to 1997

sweep programs the fall of m1 and rebirth of the medium of exchange this paper investigates the effect of sweep programs on m1 using dynamic simulations of money demand over 1994 2000 the postsample period constitutes when sweep programs have been in effect all models generate predictions systematically above reported m1 using data on newly initiated programs test findings indicate that sweeps account for the overprediction within the conventional money demand model with a long term interest rate we construct a medium of exchange measure m1s equal to m1 plus estimated holdings of sweep balances m1s velocity compares favorably with that of broader aggregates evidence indicates cointegration within m1s money demand

signalling effects of monetary policy we develop a dynamic general equilibrium model in which the policy rate signals the central bank s view about macroeconomic developments to price setters the model is estimated with likelihood methods on a u s data set that includes the survey of professional forecasters as a measure of price setters inflation expectations this model improves upon existing perfect information models in explaining why in the data inflation expectations respond with delays to monetary impulses and remain disanchored for years in the 1970s u s monetary policy is found to signal persistent inflationary shocks explaining why inflation and inflation expectations were so persistently heightened the signalling effects of monetary policy also explain why inflation expectations adjusted more sluggishly than inflation after the robust monetary tightening of the 1980s

the return of the liquidity effect a study of the short run relation between money growth and interest rates in this article i use band pass filters to investigate the short run relationship between money growth and interest rates i find a negative correlation between short run movements in money growth and interest rates which i interpret as evidence that the liquidity effect dominates the anticipated inflation effect

monetary facts revisited abstract this paper uses data from 46 economies over the post war period to revisit two key monetary facts i the link between money growth and inflation and ii the link between credit growth and financial crises the analysis reveals that the former has weakened over time while the latter has become stronger this suggests that there is an inverse relationship between the two monetary facts the money inflation link is weak and the credit crisis nexus is strong when inflation is low and financial systems are liberalised while the reverse holds true in environments of high inflation and less liberalised financial systems

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

liquidity preference and financial intermediation we examine the characteristics of optimal monetary policies in a general equilibrium model with incomplete markets markets are incomplete because of uninsured preference uncertainty and because productive capital is traded infrequently rational individuals are willing to hold a liquid asset money at a premium monetary policy interacts with existing flnancial institutions to determine this premium as well as the level of precautionary holdings we show that inflation is expansionary and that the optimal inflation rate is positive if there is no operative banking system the tobin effect otherwise efficiency requires that money be undominated in its rate of retum the friedman rule we analyse the preference for liquidity and evaluate the effects of monetary policy in a framework where individuals optimize and goods and asset markets are competitive liquidity needs of individuals and characteristics of assets are consequences of the structure of preferences technology and information equilibrium is compatible with diiferences in the rates of retum on assets differing in liquidity with divergences between household savings and aggregate investment in productive capital and distortion of household consumption plans we examine how these quantities are determined in altemative financial environments the extent to which monetary or interest rate policies are effective and desirable and the relative efficiency of altemative instruments which serve private liquidity needs we find that monetary policy is effective and infiation is expansionary if the consumption plans of individuals are constrained by the lack of liquidity at the same time such expansion can be welfare inferior intermediation which allows liquid assets to be issued against productive investment is both feasible and desirable unlike infiation intermediation achieves welfare enhancing expansion this allows a comparison of the tobin effect tobin 1965 and the friedman mle friedman 1969 in a general equilibrium model cmdely speaking the first indicates that infiation is desirable while the other claims that defiation is the difference as we show depends on the degree of intermediation money and productive capital are simultaneously held by individuals even when money has a lower rate of retum this is due to the fact that money is liquid it can be used to pay for goods at any time and in all states of nature capital on the other

predicting inflation does the quantity theory help i introduction inflation forecasting has played a key role in recent u s monetary policy and this has led to a renewed search for variables that serve as good indicators of future inflation one frequently used indicator based on the phillips curve is the unemployment rate or a similar measure of the output gap as in gerlach and svensson 2003 clark and mccracken 2003 mankiw 2001 and gali and gertler 1999 the phillips curve is believed by many to be the preferred tool for forecasting inflation see e g mankiw 2001 stock and watson 1999a blinder 1997 though as argued by sargent 1999 its use in formulating monetary policy is not without controversy another approach based on the quantity theory of money uses monetary aggregates to predict inflation despite the strong theoretical motivation for this approach though there is little evidence that measures of the nominal money supply are useful for predicting inflation relative to a conventional unemployment rate phillips curve model see stock and watson 1999a for a detailed analysis of the forecast performance of popular inflation indicators stock and watson s results indicate that even simple univariate time series models generally forecast about as well as models that include measures of the money supply so that it is hard to make the case that nominal money supply data have any predictive content for inflation 1 this article evaluates inflation forecasts made by models that allow for prices money and output to be cointegrated and in the process reexamines the question of whether monetary aggregates have marginal predictive content for inflation our work is motivated in part by economic theory as the presence of a cointegrating relationship among the series we look at corresponds to an implicit assumption that prices the money supply and output hang together in the long run an implicit feature of most analyses based on the quantity theory from a statistical point of view a system with cointegrated regressors does not have a finite order vector autoregressive var representation so that a var in differences will be misspecified and may not forecast well regardless of the relevance of the included variables our analysis is therefore focused on the questions are there gains in terms of forecast accuracy from imposing the restriction that prices money and output are cointegrated does it matter whether cointegrating restrictions are imposed a priori based on economic theory or can they be estimated and do models imposing cointegration among prices money and output forecast inflation as well as the phillips curve and other alternative models the econometric framework that we employ is similar to that of stock and watson 1999a but differs from theirs in two ways first stock and watson 1999a consider one year horizon inflation forecasts whereas we consider forecast horizons of up to five years this is potentially important in our context as we include versions of the quantity theory of money in our analysis a theory that arguably may not yield substantive gains to forecasting in the short run additionally future inflation at many horizons is in general of interest to policy makers even if the weight attached to inflation at different horizons is a matter of individual preference so that long run predictions are only unuseful if and when they fail to have marginal predictive content for inflation 2 a second difference between our work and that of stock and watson 1999a is that some of our models differ from theirs including those that impose quantity theory based cointegrating restrictions for example in these types of models we 1 impose a cointegration restriction derived from the assumption of stationary velocity and 2 estimate cointegrating restrictions we also examine a fairly broad variety of linear models including simple autoregressive ar models in levels and differences conventional unemployment rate phillips curve models and var models in levels and differences with money prices and output

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

on the stability of money demand abstract we show that regulatory changes that occurred in the banking sector in the early 1980s that considerably weakened regulation q can explain the apparent instability of money demand starting in the same period we evaluate the effects of the regulatory changes using a model that goes beyond aggregates as m1 and treats currency and different deposit types as alternative means of payments we use the model to construct a new monetary aggregate that performs remarkably well for all the period 1915 2012

endogenous money or sticky prices abstract what explains the correlations between nominal and real variables in the postwar us data are these correlations indicative of significant nominal rigidity or do they simply reflect the particular way that monetary policymakers react to developments in the real economy to answer these questions this paper uses maximum likelihood to estimate a model of endogenous money this model allows but does not require nominal prices to be sticky the results show that nominal price rigidity over and above endogenous money plays a role in accounting for key features of the data

decomposing the effects of monetary policy using an external instruments svar we study the effects of monetary policy on economic activity separately identifying the effects of a conventional change in the fed funds rate from the policy of forward guidance we use a structural var identified using external instruments from futures market data the response of output to a fed funds rate shock is found to be consistent with typical monetary var analyses however the effect of a forward guidance shock that increases long term interest rates has an expansionary effect on output this counterintuitive response is shown to be tied to the asymmetric information between the federal reserve and the public

shocking language understanding the macroeconomic effects of central bank communication we explore how the multi dimensional aspects of information released by the fomc has effects on both market and real economic variables using tools from computational linguistics we measure the information released by the fomc on the state of economic conditions as well as the guidance the fomc provides about future monetary policy decisions employing these measures within a favar framework we find that shocks to forward guidance are more important than the fomc communication of current economic conditions in terms of their effects on market and real variables nonetheless neither communication has particularly strong effects on real economic variables

the demand for m3 in the euro area in this paper an empirically stable money demand model for m3 in the euro area is constructed starting with a multivariate system three cointegrating relationships with economic content are found i the spread between the long term and the short term nominal interest rates ii the long term real interest rate and iii a long run demand for broad money m3 there is evidence that the determinants of m3 money demand are weakly exogenous with respect to the long run parameters hence following a general to specific modelling approach a parsimonious conditional error correction model for m3 money demand is derived which can be interpreted economically for the conditional model long run and short run parameter stability is extensively tested and not rejected copyright 2001 john wiley sons ltd

a closer look at long run u s money demand linear or nonlinear error correction with m0 m1 or m2 i introduction the stability of money demand has been a long standing issue 1 lucas 1988 informally analyzes the stability of a log linear m1 money demand function and concludes that real money demand is a stable function and he supports earlier findings of meltzer 1963 with an income or wealth elasticity of around unity 2 with the development of cointegration methods engle and granger 1987 numerous empirical studies have applied these techniques to long run u s money demand examples are baba hendry and starr 1992 haferand jansen 1991 hoffman and rasche 1991 and miller 1991 who find support for a cointegrated money demand model with either m1 or m2 3 king et al 1991 also find support for cointegration with m2 and a short term interest rate in contrast to these studies others have argued against a stable u s money demand function in the postwar period for example friedman and kuttner 1992 do not find support for cointegration particularly when the period march 1970 to april 1990 is considered similarly miyao 1996 studies the behavior of the m2 money demand function over the period from 1959 to 1993 with quarterly data and various interest rates in levels and in logs miyao concludes that m2 is not a useful intermediate target for monetary policy in the 1990s 4 however carlson et al 2000 reach the conclusion that m2 does have predictive content for nominal economic activity and that the real m2 money demand function is stable but only after accounting for financial innovation in the first half of the 1990s two recent papers ball 2001 and stock and watson 1993 focus on especially long data sets for the united states and m1 stock and watson 1993 analyze various estimation methods for cointegrating relationships and illustrate their performance for money demand functions with annual data from 1900 to 1987 they pay particular attention to the postwar period and use monthly data in addition to annual data for this period they employ a semi log linear real m1 money demand model with real net national product and the level of the 6 mo commercial paper rate for the postwar period they also consider the 90 day treasury bill rate and the 10 yr treasury bond rate they compare and contrast their results to those of various others they also carry out recursive estimations to check their results for stability stock and watson 1993 conclude that a long span of data is needed to estimate long run money demand functions precisely their overall evidence is in favor of a stable long run money demand function with an income elasticity near one and an interest rate semielasticity near 0 10 however the postwar data are found to be not very informative a lack of low frequency variation in the postwar data as suggested by lucas 1988 does not allow a disentangling of the effects of output and interest rates on money demand for this time period estimates are imprecise and sensitive to subsample specifications due to substantial colinearity ball 2001 revisits the m1 money demand model of stock and watson 1993 using the same data set but extended through 1996 he applies the same array of estimation techniques as stock and watson did ball obtains precise estimates over the postwar period for his extended data set an income elasticity of approximately 0 5 and a semielasticity of 0 05 for the interest rate he does not find support for a velocity specification the m1 model is not stable over the period 1900 1996 lutkepohl terasvirta and wolters 1999 apply a nonlinear error correction model with smooth transition adjustment to capture instabilities in the linear cointegration model the long run equilibrium is described by a linear cointegrating relation and the adjustment to this long run equilibrium is nonlinear they analyze german m1 money demand granger and terisvirta 1993 terasvirta 1998 and van dijk terasvirta and franses 2002 provide details on the econometric theory for estimating and testing such nonlinear models

measuring money growth when financial markets are changing abstract this article considers constructing monetary aggregates in the presence of financial market innovations and changes in the relationship between individual assets and output we propose two procedures for constructing a monetary aggregate with the objective of providing a reliable monetary leading indicator of nominal gdp in the first subaggregates discretely switch in and out in the second the aggregate s growth is a time varying weighted average of the growth of the subaggregates where the weights follow a multivariate random walk these procedures are used to examine augmenting m2 with stock and or bond mutual funds the alternative aggregates are broadly similar to m2 but during 1992 1993 they outperform m2

u s narrow money for the twenty first century i introduction though money retains its fundamental role in a market economy money measures have been noticeably de emphasized within the conduct of u s monetary policy the federal open market committee fomc stopped reporting annual growth objectives for monetary aggregates although it states that money supply still has value for gauging economic conditions board of governors 2000 however a growing body of research calls for returning monetary aggregates to a more prominent role within monetary policy meltzer 1998 asserts that the view of persistent money growth as being the source of inflation is again widely accepted perhaps more firmly held by some central bank governors now than at any time in the twentieth century nelson 2002 provides evidence that base money has a significant effect on output relative to potential in the united states and united kingdom even after controlling for the short term real interest rate nelson 2003 argues that money growth governs the mean and dynamics of inflation in present day new keynesian models leeper and roush 2003 find evidence of an essential role for m2 within the transmission of monetary policy even after controlling for the nominal interest rate 1 this article focuses on the role of sweep programs in properly measuring narrow money in a sweep program banks move a portion of funds from customer demand deposits dds or other checkable deposits ocds into instruments with zero statutory reserve requirements we examine the effects of two types of sweep programs in the united states retail sweep programs and commercial demand deposit sweep programs narrow transactions based money historically has played a key role in the conduct of monetary policy as hafer and wheelock 2001 explain m1 served as the measure of money within the st louis model although monetarists had long been divided over whether a narrow or broad aggregate was the preferable target for monetary policy the fomc appeared to focus on m1 during the 1970s and early 1980s publishing their target ranges for money growth in terms of m1 hafer and wheelock 2001 though state that deviations in m1 velocity from its upward trend beginning in the early 1980s caused instability within the st louis model hoffman and rasche 1991 and hoffman et al 1995 place dummy variables in their vector error correction mechanisms to capture observed shifts in m1 velocity what attention remains on the money supply seems to be focused on broad rather than narrow aggregates but the broad aggregates have not escaped difficulties duca 2000 and hafer and wheelock 2001 document a deviation of m2 velocity from its long run trend in the early 1990s sometimes characterized as the missing m2 episode duca and vanhoose 2004 state that one response was to replace m2 with mzm consistent with the view that heightened substitution between small time deposits and mutual funds other than money market mutual funds mmmfs largely accounted for the instability in m2 velocity but as they go on to discuss m2 and mzm velocity encountered problems in the early 2000s plunging in ways not in line with opportunity cost variables duca and van hoose 2004 state that broader aggregates may have become more vulnerable to portfolio substitution involving stock and mutual funds other than mmmf narrow money has also been used extensively in examining money demand a sizable body of research has emerged that empirically investigates the demand for m1 especially using cointegration techniques hoffman and rasche 1991 hoffman et al 1995 dutkowsky and atesoglu 2001 and ball 2001 provide evidence of a stable long run money demand equation using m1 ball 2002 generates further support with m1 and establishes a correspondence between the partial adjustment formulation and the vector error correction model yet research and policy making using narrow money is currently being hampered by the lack of an accurate measure of transactions based money

two illustrations of the quantity theory of money breakdowns and revivals by extending his data we document the instability of low frequency regression coefficients that lucas 1980 used to express the quantity theory of money we impute the differences in these regression coefficients to differences in monetary policies across periods a dsge model estimated over a subsample like lucas s implies values of the regression coefficients that confirm lucas s results for his sample period but perturbing monetary policy rule parameters away from the values estimated over lucas s subsample alters the regression coefficients in ways that reproduce their instability over our longer sample jel c51 e23 e31 e43 e51 e52 robert e lucas jr 1980 used near unit slopes of univariate regressions of moving averages of inflation and interest rates on money growth for the united states for the period 1953 1977 to illustrate two central implications of the quantity theory of money that a given change in the rate of change in the quantity of money induces i an equal change in the rate of price inflation and ii an equal change in nominal rates of interest lucas said that those two quantity theoretic propositions

the effects of money growth on inflation and interest rates across spectral frequency bands band spectral regression techniques are used to identify the frequency bands that are most important in the relationships between money growth and inflation and between money growth and the nominal interest rate the results show that cycles in the growth rate of m1 from one to two years long produce higher frequency cycles in inflation and two distinct sets of higher frequency cycles in changes in the nominal interest rate the results support models where predictable changes in money growth produce liquidity and anticipated inflation effects on nominal interest rates copyright 1994 by ohio state university press

federal reserve policy viewed through a money supply lens abstract federal reserve nonborrowed reserve supply systematically responded to changes in inflation and in the output gap over the period 1969 2000 while the feedback from output gap is always negative the response of money supply to changes in inflation varies considerably across time nonborrowed reserves decreased with inflation in the post 1979 period and increased in the pre 1979 period applying a standard macro model the estimated reaction functions are shown to ensure equilibrium determinacy viewed through the money supply lens federal reserve policy substantially changed over time but has never allowed for endogenous fluctuations which contrasts conclusions drawn from federal funds rate analyses

an evaluation of friedman s monetary instability hypothesis in this article i examine what i call milton friedman s monetary instability hypothesis drawing on friedman s work i argue that there are two main components to this view the first component is the idea that deviations between the public s demand for money and the supply of money are an important source of economic fluctuations the second component of this view is that these deviations are primarily caused by fluctuations in the supply of money rather than the demand for money each of these components can be tested independently to do so i estimate an otherwise standard new keynesian model amended to include a money demand function consistent with friedman s work and a money growth rule for a period from 1875 to 1963 this structural model allows me to separately identify shocks to the money supply and shocks to money demand i then use variance decompositions to assess the relative importance of shocks to the supply and demand for money i find that shocks to the monetary base can account for up to 28 of the fluctuations in output whereas money demand shocks can account for less than 1 of such fluctuations this provides support for friedman s view

two illustrations of the quantity theory of money of two central implications of the quantity theory of money that a given change in the rate of change in the quantity of money induces i an equal change in the rate of price inflation and ii an equal change in nominal rates of interest the illustrations were obtained by comparing moving averages of the three variables in question using quarterly u s time series for the period 1953 77 readers may find the results of interest as additional confirmation of the quantity theory as an example of one way in which the quantity theoretic relationships can be uncovered via atheoretical methods from time series which are subject to a variety of other forces or as a measure of the extent to which the inflation and interest rate experience of the postwar period can be understood in terms of purely classical monetary forces the theoretical background of the study is reviewed very briefly as it is familiar material in the next section the data processing methods are described and rationalized in section ii the illustrations

monetary policy and monetary asset substitution abstract this paper shows that changing the target federal funds rate induces changes in relative user costs of monetary assets estimated morishima elasticities of substitution from the fourier flexible form reveal greater substitution from transactions assets and savings deposits into small time deposits than into retail money market mutual funds

sufficient information in structural vars abstract necessary and sufficient conditions under which a var contains sufficient information to estimate the structural shocks are derived on the basis of this theoretical result we propose two simple tests to detect informational deficiency and a procedure to amend a deficient var a simulation based on a dsge model with fiscal foresight suggests that our method correctly identifies and fixes the informational problem in an empirical application we show that a bivariate var including unemployment and labor productivity is informationally deficient once the relevant information is included into the model technology shocks appear to be contractionary

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