Working Paper: CEPR ID: DP629
Authors: Michael J. Artis
Abstract: A smooth progression from Stage Two to Stage Three of EMU requires that the type of policy planned for Stage Three should be foreshadowed in Stage Two. Two possibilities for that policy are monetary targeting or an interest rate policy feeding back on a nominal variable. The paper re-examines the evidence of the 1980s to determine the nature and stability of reduced form relationships involving money and interest rates. Geweke linear feedback measures are presented for a subset of the G7 countries (France, Germany, Italy, the United Kingdom and the United States). Greater stability is found in relationships involving money than expected, while interest rate leads, though significant, are often at long lags. In addition, aggregate ERM money demand functions are shown to be stable. These results, though not conclusive, provide support for the case for monetary targeting.
Keywords: money; linear feedback; interest rates; money demand; EMU
JEL Codes: C1; E41; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| financial innovations (O16) | weakening of relationship between monetary aggregates and output (E19) |
| financial innovations (O16) | weakening of relationship between monetary aggregates and prices (E19) |
| M2 (E51) | real output (in the United States) (E23) |
| M0 (E41) | real output (in the United Kingdom) (E23) |
| M0 (E41) | prices (in the United Kingdom) (P22) |
| short-term interest rates (E43) | economic activity variables (E20) |
| aggregate European money demand functions (E19) | prospects for successful monetary targeting in Europe (E52) |