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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. Barro, Robert J, 1977. "Unanticipated Money Growth and Unemployment in the United States," American Economic Review, American Economic Association, American Economic Association, vol. 67(2), pages 101-15, March.
  2. Robert J. Shiller, 1980. "Can the Fed Control Real Interest Rates?," NBER Chapters, National Bureau of Economic Research, Inc, in: Rational Expectations and Economic Policy, pages 117-167 National Bureau of Economic Research, Inc.
  3. Frederic S. Mishkin, 1981. "The Real Interest Rate: An Empirical Investigation," NBER Working Papers 0622, National Bureau of Economic Research, Inc.
  4. Grossman, Sanford J & Weiss, Laurence, 1982. "Heterogeneous Information and the Theory of the Business Cycle," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 90(4), pages 699-727, August.
  5. Barro, Robert J., 1976. "Rational expectations and the role of monetary policy," Journal of Monetary Economics, Elsevier, Elsevier, vol. 2(1), pages 1-32, January.
  6. Christopher A. Sims, 1980. "Comparison of Interwar and Postwar Business Cycles: Monetarism Reconsidered," NBER Working Papers 0430, National Bureau of Economic Research, Inc.
  7. 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, American Economic Association, vol. 67(3), pages 478-86, June.
  8. Barro, Robert J, 1980. "A Capital Market in an Equilibrium Business Cycle Model," Econometrica, Econometric Society, Econometric Society, vol. 48(6), pages 1393-1417, September.
  9. Fama, Eugene F. & Gibbons, Michael R., 1982. "Inflation, real returns and capital investment," Journal of Monetary Economics, Elsevier, Elsevier, vol. 9(3), pages 297-323.
  10. Sims, Christopher A, 1972. "Money, Income, and Causality," American Economic Review, American Economic Association, American Economic Association, vol. 62(4), pages 540-52, September.
  11. Fama, Eugene F, 1975. "Short-Term Interest Rates as Predictors of Inflation," American Economic Review, American Economic Association, American Economic Association, vol. 65(3), pages 269-82, June.
  12. Garbade, Kenneth & Wachtel, Paul, 1978. "Time variation in the relationship between inflation and interest rates," Journal of Monetary Economics, Elsevier, Elsevier, vol. 4(4), pages 755-765, November.
  13. Sargent, Thomas J, 1978. "Estimation of Dynamic Labor Demand Schedules under Rational Expectations," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 86(6), pages 1009-44, December.
  14. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, Elsevier, vol. 4(2), pages 103-124, April.
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