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Money, Real Interest Rates, and Output: A Reinterpretation of Postwar U.S. Data

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  • Robert B. Litterman
  • Laurence Weiss

Abstract

This paper reexamines both monthly and quarterly U.S. postwar data to investigate if the observed comovements between money, real interestrates, prices and output are compatible with the money-real interest-output link suggested by existing monetary theories of output, which include both Keynesian and equilibrium models.The major empirical findings are these;1) In both monthly and quarterly data, we cannot reject the hypothesis that the ex ante real rate is exogenous, or Granger-causally prior in the context of a four-variable system which contains money, prices, nominal interest rates and industrial production.2) In quarterly data, there is significantly more information con-tained in either the levels of expected inflation or the innovationof this variable for predicting future output, given current and lagged output, than in any other variable examined (money, actualinflation, nominal interest rates, or ex ante real rates). The effect of an inflation innovation on future output is unambiguously negative. The first result casts strong doubt on the empirical importance of existing monetary theories of output, which imply that money should have a causal role on the ex ante real rates. The second result would appear incompatible with most demand driven models of output.In light of these results, we propose an alternative structural model which can account for the major dynamic interactions among the variables.This model has two central features: i) output is unaffected by money supply;and ii) the money supply process is motivated by short-run price stability.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 1077.

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Date of creation: Feb 1983
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Publication status: published as Econometrica, Vol. 53, no. 1 (1985): 129-156.
Handle: RePEc:nbr:nberwo:1077

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  1. Robert J. Shiller, 1979. "Can the Fed Control Real Interest Rates?," NBER Working Papers 0348, National Bureau of Economic Research, Inc.
  2. Sargent, Thomas J, 1978. "Estimation of Dynamic Labor Demand Schedules under Rational Expectations," Journal of Political Economy, University of Chicago Press, vol. 86(6), pages 1009-44, December.
  3. Nelson, Charles R & Schwert, G William, 1977. "Short-Term Interest Rates as Predictors of Inflation: On Testing the Hypothesis That the Real Rate of Interest is Constant," American Economic Review, American Economic Association, vol. 67(3), pages 478-86, June.
  4. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
  5. Christopher A. Sims, 1980. "Comparison of Interwar and Postwar Business Cycles: Monetarism Reconsidered," NBER Working Papers 0430, National Bureau of Economic Research, Inc.
  6. Robert J. Barro, 1979. "A Capital Market In an Equilibrium Business Cycle Model," NBER Working Papers 0326, National Bureau of Economic Research, Inc.
  7. Garbade, Kenneth & Wachtel, Paul, 1978. "Time variation in the relationship between inflation and interest rates," Journal of Monetary Economics, Elsevier, vol. 4(4), pages 755-765, November.
  8. Sanford Grossman & Laurence Weiss, 1980. "Heterogeneous Information and the Theory of the Business Cycle," Cowles Foundation Discussion Papers 558, Cowles Foundation for Research in Economics, Yale University.
  9. Barro, Robert J, 1977. "Unanticipated Money Growth and Unemployment in the United States," American Economic Review, American Economic Association, vol. 67(2), pages 101-15, March.
  10. Fama, Eugene F, 1975. "Short-Term Interest Rates as Predictors of Inflation," American Economic Review, American Economic Association, vol. 65(3), pages 269-82, June.
  11. Frederic S. Mishkin, 1981. "The Real Interest Rate: An Empirical Investigation," NBER Working Papers 0622, National Bureau of Economic Research, Inc.
  12. Barro, Robert J., 1976. "Rational expectations and the role of monetary policy," Journal of Monetary Economics, Elsevier, vol. 2(1), pages 1-32, January.
  13. Sims, Christopher A, 1972. "Money, Income, and Causality," American Economic Review, American Economic Association, vol. 62(4), pages 540-52, September.
  14. Fama, Eugene F. & Gibbons, Michael R., 1982. "Inflation, real returns and capital investment," Journal of Monetary Economics, Elsevier, vol. 9(3), pages 297-323.
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