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The Relationship between Financial Indicators and Economic Activity: Some Further Evidence

Author

Listed:
  • Glenn Stevens

    (Reserve Bank of Australia)

  • Susan Thorp

    (Reserve Bank of Australia)

Abstract

This paper focusses on the empirical relationship between financial indicators (monetary and credit aggregates and short-term interest rates) and measures of economic activity. It aims to supplement an earlier paper by Bullock, Morris and Stevens (1988) (BMS), which explored these issues. BMS tentatively concluded that short-term interest rates and the narrow aggregate M1 had a reasonably good leading relationship with private final demand. Broad monetary and credit aggregates tended to be lagging indicators, and the intermediate aggregates (M3 and bank lending) presented a mixed picture. This earlier paper relied on simple graphical and correlation-based techniques to draw these conclusions. The same questions are addressed in this paper, this time using more rigorous statistical testing techniques. Vector auto-regression (VAR) analysis is used to identify leading and lagging relationships among the data. All data are pre-tested for the presence of deterministic trends and unit roots, and differenced and detrended accordingly, before the models are estimated. Estimation is over the period 1969–1988 (given available data), using seasonally adjusted quarterly series. Results confirm that the broader aggregates generally lag activity, however there is no strong evidence of a leading relationship between the short-term interest rate (or M1) and activity. The latter suggests a complex relationship between interest rates and activity over time; a process influenced by the operation of monetary policy, which cannot be satisfactorily unravelled using the techniques employed here. The data set of BMS is also extended in this paper to allow a preliminary examination of the tradeable goods sector. Models including the exchange rate, foreign demand and prices, as well as domestic activity and financial variables are estimated. Results from these tests suggest an effect of the exchange rate on imports and exports, which is consistent with a link between monetary policy and the tradeable goods sector.

Suggested Citation

  • Glenn Stevens & Susan Thorp, 1989. "The Relationship between Financial Indicators and Economic Activity: Some Further Evidence," RBA Research Discussion Papers rdp8903, Reserve Bank of Australia.
    • Handle: RePEc:rba:rbardp:rdp8903
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    Cited by:

    1. Ellis W. Tallman & Naveen Chandra, 1996. "The Information Content of Financial Aggregates in Australia," RBA Research Discussion Papers rdp9606, Reserve Bank of Australia.
    2. Ellis W. Tallman & Naveen Chandra, 1997. "Financial Aggregates as Conditioning Information for Australian Output and Inflation," RBA Research Discussion Papers rdp9704, Reserve Bank of Australia.
    3. Edgar Wilson, 1990. "Comment: on ‘Monetary Policy under Deregulation’," Australian Economic Review, The University of Melbourne, Melbourne Institute of Applied Economic and Social Research, vol. 23(2), pages 93-94, June.
    4. Mwankemwa, Lusajo P. & Mlamka, Bonaventura, 2022. "Effects of Monetary Policy on Bank’s Credit Dynamics in Tanzania," African Journal of Economic Review, African Journal of Economic Review, vol. 10(2), March.
    5. Gordon de Brouwer & Irene Ng & Robert Subbaraman, 1993. "The Demand for Money in Australia: New Tests on an Old Topic," RBA Research Discussion Papers rdp9314, Reserve Bank of Australia.
    6. Karfakis, Costas I & Parikh, Ashok, 1993. "A Cointegration Approach to Monetary Targeting in Australia," Australian Economic Papers, Wiley Blackwell, vol. 32(60), pages 53-72, June.
    7. Leon Berkelmans, 2005. "Credit and Monetary Policy: An Australian SVAR," RBA Research Discussion Papers rdp2005-06, Reserve Bank of Australia.
    8. Jerome Fahrer & Thomas Rohling, 1992. "Financial Deregulation and the Monetary Transmission Mechanism," Australian Economic Review, The University of Melbourne, Melbourne Institute of Applied Economic and Social Research, vol. 25(1), pages 33-43, January.
    9. David Parker, 1990. "Monetary Policy under Deregulation," Australian Economic Review, The University of Melbourne, Melbourne Institute of Applied Economic and Social Research, vol. 23(2), pages 80-91, June.
    10. Malcolm Edey & Jill Pleban, 1991. "Indicators of Economic Activity: A Review," RBA Research Discussion Papers rdp9102, Reserve Bank of Australia.

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