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The Quantity Theory of Money is Valid. The New Keynesians are Wrong!

  • Hillinger, Claude
  • Süssmuth, Bernd

We test the quantity theory of money (QTM) using a novel approach and a large new sample. We do not follow the usual approach of first differentiating the logarithm of the Cambridge equation to obtain an equation relating the growth rate of real GDP, the growth rate of money and inflation. These variables must then again be ‘integrated’ by averaging in order to obtain stable relationships. Instead we suggest a much simpler procedure for testing directly the stability of the coefficient of the Cambridge equation. For 125 countries and post-war data we find the coefficient to be surprisingly stable. We do not select for high inflation episodes as was done in most empirical studies; inflation rates do not even appear in our data set. Much work supporting the QTM has been done by economic historians and at the University of Chicago by Milton Friedman and his associates. The QTM was a foundation stone of the monetarist revolution. Subsequently belief in it waned. The currently dominant New Keynesian School, implicitly or explicitly denies the validity of the QTM. We survey this history and argue that the QTM is valid and New Keynesians are wrong.

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Paper provided by University of Munich, Department of Economics in its series Discussion Papers in Economics with number 6987.

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Date of creation: 30 Oct 2008
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Handle: RePEc:lmu:muenec:6987
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  1. Gerald P. Dwyer, Jr. & R.W. Hafer, 1999. "Are money growth and inflation still related?," Economic Review, Federal Reserve Bank of Atlanta, issue Q2, pages 32-43.
  2. Milton Friedman, 1961. "The Lag in Effect of Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 69, pages 447.
  3. Jürgen von Hagen, 2004. "Hat die Geldmenge ausgedient?," Perspektiven der Wirtschaftspolitik, Verein für Socialpolitik, vol. 5(4), pages 423-453, November.
  4. Ray C. Fair, 2001. "On Modeling the Effects of Inflation Shocks," Cowles Foundation Discussion Papers 1300, Cowles Foundation for Research in Economics, Yale University, revised Mar 2002.
  5. George T. McCandless, Jr. & Warren E. Weber, 1995. "Some monetary facts," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Sum, pages 2-11.
  6. V. V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 2008. "New Keynesian models: not yet useful for policy analysis," Staff Report 409, Federal Reserve Bank of Minneapolis.
  7. Olivier J. Blanchard, 2008. "The State of Macro," NBER Working Papers 14259, National Bureau of Economic Research, Inc.
  8. R.W. Hafer, 2001. "What remains of monetarism?," Economic Review, Federal Reserve Bank of Atlanta, issue Q4, pages 13-33.
  9. Giordani Paolo, 2003. "On Modeling the Effects of Inflation Shocks: Comments and Some Further Evidence," The B.E. Journal of Macroeconomics, De Gruyter, vol. 3(1), pages 1-15, January.
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