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What was behind the M2 breakdown?

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Author Info

  • Cara S. Lown
  • Stavros Peristiani
  • Kenneth J. Robinson

Abstract

A deterioration in the link between the M2 monetary aggregate and GDP, along with large errors in predicting M2 growth, led the Board of Governors to downgrade the M2 aggregate as a reliable indicator of monetary policy in 1993. In this paper, we argue that the financial condition of depository institutions was a major factor behind the unusual pattern of M2 growth in the early 1990s. By constructing alternative measures of M2 based on banks’ and thrifts’ capital positions, we show that the anomalous behavior of M2 in the early 1990s disappears. Specifically, after accounting for the effect of capital constrained institutions on M2 growth, we are able to explain the unusual behavior of M2 velocity during this time period, obtain superior M2 forecasting results, and produce a more stable relationship between M2 and the ultimate goals of policy. Our work suggests that M2 may contain useful information about economic growth during periods of time when there are no major disturbances to depository institutions

(This abstract was borrowed from another version of this item.)

(This abstract was borrowed from another version of this item.)

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Bibliographic Info

Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 83.

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Date of creation: 1999
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Handle: RePEc:fip:fednsr:83

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Keywords: Money supply ; Gross domestic product ; Economic indicators;

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References

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  1. Joshua N. Feinman & Richard D. Porter, 1992. "The continuing weakness in the M2," Finance and Economics Discussion Series 209, Board of Governors of the Federal Reserve System (U.S.).
  2. Miller, Stephen M, 1991. "Monetary Dynamics: An Application of Cointegration and Error-Correction Modeling," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(2), pages 139-54, May.
  3. Lars E.O. Svensson, 1999. "Monetary policy issues for the Eurosystem," Proceedings, Federal Reserve Bank of San Francisco.
  4. David H. Small & Richard D. Porter, 1989. "Understanding the behavior of M2 and V2," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Apr, pages 244-254.
  5. Joanna Stavins, 1999. "Checking accounts: what do banks offer and what do consumers value?," New England Economic Review, Federal Reserve Bank of Boston, issue Mar, pages 3-14.
  6. Joe Peek & Eric S. Rosengren, 1992. "The capital crunch in New England," New England Economic Review, Federal Reserve Bank of Boston, issue May, pages 21-31.
  7. Koenig, Evan F., 1996. "Long-term interest rates and the recent weakness in M2," Journal of Economics and Business, Elsevier, vol. 48(2), pages 81-101, May.
  8. Arturo Estrella & Frederic S. Mishkin, 1996. "Is There a Role for Monetary Aggregates in the Conduct of Monetary Policy?," NBER Working Papers 5845, National Bureau of Economic Research, Inc.
  9. James H. Stock & Mark W. Watson, 1991. "A simple estimator of cointegrating vectors in higher order integrated systems," Working Paper Series, Macroeconomic Issues 91-3, Federal Reserve Bank of Chicago.
  10. Hafer, R.W. & Jansen, D.W., 1990. "The Demand For Money In The United States: Evidence From Cointegration Tests," Papers 9010, Erasmus University of Rotterdam - Institute for Economic Research.
  11. John V. Duca, 1992. "The case of the missing M2," Economic and Financial Policy Review, Federal Reserve Bank of Dallas, issue Q II, pages 1-24.
  12. Duca, John V., 1995. "Should bond funds be added to M2?," Journal of Banking & Finance, Elsevier, vol. 19(1), pages 131-152, April.
  13. Martin Feldstein & James H. Stock, 1993. "The Use of Monetary Aggregate to Target Nominal GDP," NBER Working Papers 4304, National Bureau of Economic Research, Inc.
  14. John B. Carlson & Sharon E. Parrott, 1991. "The demand for M2, opportunity cost, and financial change," Economic Review, Federal Reserve Bank of Cleveland, issue Q II, pages 2-11.
  15. Peter C.B. Phillips & Sam Ouliaris, 1987. "Asymptotic Properties of Residual Based Tests for Cointegration," Cowles Foundation Discussion Papers 847R, Cowles Foundation for Research in Economics, Yale University, revised Jul 1988.
  16. Friedman, Benjamin M & Kuttner, Kenneth N, 1992. "Money, Income, Prices, and Interest Rates," American Economic Review, American Economic Association, vol. 82(3), pages 472-92, June.
  17. Evan F. Koenig, 1996. "Forecasting M2 growth: an exploration in real time," Economic and Financial Policy Review, Federal Reserve Bank of Dallas, issue Q II, pages 16-26.
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Citations

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Cited by:
  1. Jacky Mallett, 2009. "What are the limits on Commercial Bank Lending?," Quantitative Finance Papers 0904.1426, arXiv.org, revised Jan 2011.
  2. Paresh Narayan & Seema Narayan & Vinod Mishra, 2009. "Estimating money demand functions for South Asian countries," Empirical Economics, Springer, vol. 36(3), pages 685-696, June.
  3. John B. Carlson & Dennis L. Hoffman & Benjamin D. Keen & Robert H. Rasche, 1999. "Results of a study of the stability of cointegrating relations comprised of broad monetary aggregates," Working Paper 9917, Federal Reserve Bank of Cleveland.
  4. Michael Dotsey & Carl D. Lantz & Lawrence Santucci, 2000. "Is money useful in the conduct of monetary policy?," Economic Quarterly, Federal Reserve Bank of Richmond, issue Fall, pages 23-48.
  5. Ramon Moreno & Reuven Glick, 2001. "Is money still useful for policy in East Asia?," Pacific Basin Working Paper Series 01-12, Federal Reserve Bank of San Francisco.
  6. Seth B. Carpenter & Joe Lange, 2003. "Money demand and equity markets," Finance and Economics Discussion Series 2003-03, Board of Governors of the Federal Reserve System (U.S.).

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