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What was behind the M2 breakdown?

Author Info

Listed author(s):
  • Cara 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.

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File URL: http://www.dallasfed.org/assets/documents/banking/fiswp/fiswp9902.pdf
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Paper provided by Federal Reserve Bank of Dallas in its series Financial Industry Studies Working Paper with number 99-2.

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Date of creation: 1999
Handle: RePEc:fip:feddfi:99-2
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Keywords: Monetary policy;

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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. repec:bla:restud:v:57:y:1990:i:1:p:99-125 is not listed on IDEAS
  3. 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 139-154, May.
  4. Svensson, Lars E. O., 1999. "Monetary policy issues for the Eurosystem," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 51(1), pages 79-136, December.
  5. Hansen, Bruce E., 1992. "Efficient estimation and testing of cointegrating vectors in the presence of deterministic trends," Journal of Econometrics, Elsevier, vol. 53(1-3), pages 87-121.
  6. 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.
  7. Stock, James H & Watson, Mark W, 1993. "A Simple Estimator of Cointegrating Vectors in Higher Order Integrated Systems," Econometrica, Econometric Society, vol. 61(4), pages 783-820, July.
  8. Duca, John V., 1995. "Should bond funds be added to M2?," Journal of Banking & Finance, Elsevier, vol. 19(1), pages 131-152, April.
  9. 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.
  10. 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.
  11. 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.
  12. 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.
  13. 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.
  14. 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.
  15. Estrella, Arturo & Mishkin, Frederic S., 1997. "Is there a role for monetary aggregates in the conduct of monetary policy?," Journal of Monetary Economics, Elsevier, vol. 40(2), pages 279-304, October.
  16. Hafer, R W & Jansen, Dennis W, 1991. "The Demand for Money in the United States: Evidence from Cointegration Tests," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(2), pages 155-168, May.
  17. Martin Feldstein & James H. Stock, 1994. "The Use of a Monetary Aggregate to Target Nominal GDP," NBER Chapters,in: Monetary Policy, pages 7-69 National Bureau of Economic Research, Inc.
  18. Phillips, Peter C B & Ouliaris, S, 1990. "Asymptotic Properties of Residual Based Tests for Cointegration," Econometrica, Econometric Society, vol. 58(1), pages 165-193, January.
  19. Friedman, Benjamin M & Kuttner, Kenneth N, 1992. "Money, Income, Prices, and Interest Rates," American Economic Review, American Economic Association, vol. 82(3), pages 472-492, June.
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Cited by:

  1. Jacky Mallett, 2009. "What are the limits on Commercial Bank Lending?," Papers 0904.1426, arXiv.org, revised Aug 2012.
  2. Judson, Ruth & Schlusche, Bernd & Wong, Vivian, 2014. "Demand for M2 at the Zero Lower Bound: The Recent U.S. Experience," Finance and Economics Discussion Series 2014-22, Board of Governors of the Federal Reserve System (U.S.).
  3. George A. Kahn & Scott Benolkin, 2007. "The role of money in monetary policy: why do the Fed and ECB see it so differently?," Economic Review, Federal Reserve Bank of Kansas City, issue Q III, pages 5-36.
  4. 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.
  5. McCallum, Bennett T. & Nelson, Edward, 2010. "Money and Inflation: Some Critical Issues," Handbook of Monetary Economics,in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 3, pages 97-153 Elsevier.
  6. Carlson, John B. & Hoffman, Dennis L. & Keen, Benjamin D. & Rasche, Robert H., 2000. "Results of a study of the stability of cointegrating relations comprised of broad monetary aggregates," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 345-383, October.
  7. Borensztein, Eduardo & Lee, Jong-Wha, 2002. "Financial crisis and credit crunch in Korea: evidence from firm-level data," Journal of Monetary Economics, Elsevier, vol. 49(4), pages 853-875, May.
  8. Calza, Alessandro & Sousa, João, 2003. "Why has broad money demand been more stable in the euro area than in other economies? A literature review," Working Paper Series 261, European Central Bank.
  9. 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.
  10. 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.).
  11. Širůček, Martin, 2015. "Kauzalní vztah peněžní nabídky a amerického akciového trhu
    [Money supply and US stock market causality]    ," MPRA Paper 66357, University Library of Munich, Germany, revised 30 Aug 2015.
  12. Ramon Moreno & Reuven Glick, 2001. "Is money still useful for policy in East Asia?," Pacific Basin Working Paper Series 2001-12, Federal Reserve Bank of San Francisco.

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