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Direct Effects of Money on Aggregate Demand: Another Look at the Evidence

Author

Listed:
  • Stephen Elias

    (Reserve Bank of Australia)

  • Mariano Kulish

    (Reserve Bank of Australia)

Abstract

Now that a number of central banks are faced with short-term nominal interest rates close to or at the zero lower bound, there is a renewed interest in the long-running debate about whether or not changes in the stock of money have direct effects. In particular, do changes in money have additional effects on aggregate demand outside of those induced by changes in short-term nominal interest rates? This paper revisits and reinterprets the empirical evidence based on single equation regressions which is quite mixed, with some results supporting and other results denying the existence of direct effects. We use a structural model with no direct effects of money to show that the finding of positive and statistically significant coefficients on real money growth can be misleading. The model generates data that, when used to estimate analogs of the empirical regressions, produce positive and statistically significant coefficients on real money growth, similar to those often found when using actual data. The problem is that single equation regressions leave out a set of variables, which in turn, gives rise to an omitted variables bias in the estimated coefficients on real money growth. Hence, they are an unreliable guide to calibrate monetary policies, in general, including at the zero lower bound.

Suggested Citation

  • Stephen Elias & Mariano Kulish, 2010. "Direct Effects of Money on Aggregate Demand: Another Look at the Evidence," RBA Research Discussion Papers rdp2010-05, Reserve Bank of Australia.
  • Handle: RePEc:rba:rbardp:rdp2010-05
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    References listed on IDEAS

    as
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    Cited by:

    1. Borivoje D. Krušković & Tina Maričić, 2015. "Monetary Targeting," Journal of Central Banking Theory and Practice, Central bank of Montenegro, vol. 4(3), pages 137-146.
    2. C. P. Barros & João Ricardo Faria & Luis A. Gil-Alana, 2017. "The demand for money in Angola," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 41(2), pages 408-420, April.
    3. Declan Trott, 2015. "Australia and the Zero Lower Bound on Interest Rates: Some Monetary Policy Options," Agenda - A Journal of Policy Analysis and Reform, Australian National University, College of Business and Economics, School of Economics, vol. 22(1), pages 5-20.

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    More about this item

    Keywords

    money; monetary base; direct effects; output gap;

    JEL classification:

    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General

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