Divisia Monetary Aggregates, the Great Ratios, and Classical Money Demand Functions
King, Plosser, Stock, and Watson (1991) evaluate the empirical relevance of a class of real business cycle models with permanent productivity shocks by analyzing the stochastic trend properties of postwar U.S. macroeconomic data. They fiÂ…nd a common stochastic trend in a three variable system that includes output, consumption, and investment, but the explanatory power of the common trend drops signiÂ…ficantly when they add money balances and the nominal interest rate. In this paper we revisit the cointegration tests in the spirit of King et al. (1991), using improved monetary aggregates whose construction has been stimulated by the Barnett critique. We show that previous rejections of the balanced-growth hypothesis and classical money demand functions can be attributed to mis-measurement of the monetary aggregate.
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