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Direct Effects of Base Money on Aggregate Demand: Theory and Evidence

  • Nelson, Edward

Meltzer (1999a) shows that real monetary base growth is a significant determinant of consumption growth in the United States, controlling for the short-term real interest rate. In this paper, I show that the same property of base money holds for total output (relative to trend or potential) in both the United States and the United Kingdom. The standard optimizing IS-LM model cannot account for this result, but I show that it can once the long-term nominal interest rate is included in the money demand function. Because the long-term real rate matters for aggregate demand, the presence of the long-term nominal rate in the money demand function increases the effect of nominal money stock changes on real aggregate demand when prices are sticky.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 2666.

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Date of creation: Jan 2001
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Handle: RePEc:cpr:ceprdp:2666
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  1. Glenn Rudebusch & Lars E.O. Svensson, 1999. "Policy Rules for Inflation Targeting," NBER Chapters, in: Monetary Policy Rules, pages 203-262 National Bureau of Economic Research, Inc.
  2. Allan H. Meltzer, 1999. "Commentary : monetary policy at zero inflation," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 261-276.
  3. Ben Bernanke & Mark Gertler, 2000. "Monetary Policy and Asset Price Volatility," NBER Working Papers 7559, National Bureau of Economic Research, Inc.
  4. Jeffrey C. Fuhrer, 2000. "Habit Formation in Consumption and Its Implications for Monetary-Policy Models," American Economic Review, American Economic Association, vol. 90(3), pages 367-390, June.
  5. Milton Friedman & Anna J. Schwartz, 1987. "Money and Business Cycles," NBER Chapters, in: Money in Historical Perspective, pages 24-77 National Bureau of Economic Research, Inc.
  6. Casares, Miguel & McCallum, Bennett T., 2006. "An optimizing IS-LM framework with endogenous investment," Journal of Macroeconomics, Elsevier, vol. 28(4), pages 621-644, December.
  7. Stefan Gerlach & Lars E.O. Svensson, 2000. "Money and Inflation in the Euro Area: A Case for Monetary Indicators?," NBER Working Papers 8025, National Bureau of Economic Research, Inc.
  8. Robert G. King & Mark W. Watson, 1995. "Money, prices, interest rates and the business cycle," Working Paper Series, Macroeconomic Issues 95-10, Federal Reserve Bank of Chicago.
  9. Allan Meltzer, 1998. "Monetarism: The issues and the outcome," Atlantic Economic Journal, International Atlantic Economic Society, vol. 26(1), pages 8-31, March.
  10. Goodfriend, Marvin, 1985. "Reinterpreting money demand regressions," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 22(1), pages 207-241, January.
  11. Neiss, Katharine & Nelson, Edward, 2001. "The Real Interest rate Gap as an Inflation Indicator," CEPR Discussion Papers 2848, C.E.P.R. Discussion Papers.
  12. Julio J. Rotemberg & Michael Woodford, 1998. "Interest-Rate Rules in an Estimated Sticky Price Model," NBER Working Papers 6618, National Bureau of Economic Research, Inc.
  13. Rudebusch, Glenn D. & Svensson, Lars E. O., 2002. "Eurosystem monetary targeting: Lessons from U.S. data," European Economic Review, Elsevier, vol. 46(3), pages 417-442, March.
  14. Bennett T. McCallum & Edward Nelson, 1999. "Performance of Operational Policy Rules in an Estimated Semiclassical Structural Model," NBER Chapters, in: Monetary Policy Rules, pages 15-56 National Bureau of Economic Research, Inc.
  15. Bennett T. McCallum & Edward Nelson, 1997. "An Optimizing IS-LM Specification for Monetary Policy and Business Cycle Analysis," NBER Working Papers 5875, National Bureau of Economic Research, Inc.
  16. Bennett T. McCallum, 2000. "Theoretical Analysis Regarding a Zero Lower Bound on Nominal Interest Rates," NBER Working Papers 7677, National Bureau of Economic Research, Inc.
  17. Julio Rotemberg & Michael Woodford, 1997. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 297-361 National Bureau of Economic Research, Inc.
  18. Stephen M. Goldfeld, 1973. "The Demand for Money Revisited," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 4(3), pages 577-646.
  19. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  20. James Tobin, 1971. "Friedman's Theoretical Framework," Cowles Foundation Discussion Papers 309, Cowles Foundation for Research in Economics, Yale University.
  21. Mervyn King, 1999. "Challenges for monetary policy : new and old," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 11-57.
  22. Peter N. Ireland, 2001. "Money's Role in the Monetary Business Cycle," NBER Working Papers 8115, National Bureau of Economic Research, Inc.
  23. Abel, Andrew B, 1983. "Optimal Investment under Uncertainty," American Economic Review, American Economic Association, vol. 73(1), pages 228-33, March.
  24. Evan F. Koenig, 1989. "Real money balances and the timing of consumption: an empirical investigation," Research Paper 8906, Federal Reserve Bank of Dallas.
  25. Hendry, David F., 1995. "Dynamic Econometrics," OUP Catalogue, Oxford University Press, number 9780198283164, March.
  26. Fuhrer, Jeffrey C & Moore, George R, 1995. "Monetary Policy Trade-offs and the Correlation between Nominal Interest Rates and Real Output," American Economic Review, American Economic Association, vol. 85(1), pages 219-39, March.
  27. William Kerr & Robert G. King, 1996. "Limits on interest rate rules in the IS model," Economic Quarterly, Federal Reserve Bank of Richmond, issue Spr, pages 47-75.
  28. Norbert Janssen, 1998. "The demand for M0 in the United Kingdom reconsidered: some specification issues," Bank of England working papers 83, Bank of England.
  29. Marvin Goodfriend, 2000. "Overcoming the zero bound on interest rate policy," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, pages 1007-1057.
  30. repec:sae:niesru:v:145:y::i:1:p:43-63 is not listed on IDEAS
  31. Rotemberg, Julio J, 1982. "Sticky Prices in the United States," Journal of Political Economy, University of Chicago Press, vol. 90(6), pages 1187-1211, December.
  32. Goodfriend, Marvin, 1985. "Reinterpreting money demand regressions Errata," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 23(1), pages 211-212, January.
  33. Richard G. Anderson & Robert H. Rasche, 2000. "The domestic adjusted monetary base," Working Papers 2000-002, Federal Reserve Bank of St. Louis.
  34. Allan H. Meltzer, 1963. "The Demand for Money: The Evidence from the Time Series," Journal of Political Economy, University of Chicago Press, vol. 71, pages 219.
  35. Michael Woodford, 1996. "Control of the Public Debt: A Requirement for Price Stability?," NBER Working Papers 5684, National Bureau of Economic Research, Inc.
  36. Ireland, Peter N., 1997. "A small, structural, quarterly model for monetary policy evaluation," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 47(1), pages 83-108, December.
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