Working Paper: NBER ID: w20134
Authors: Michael T. Belongia; Peter N. Ireland
Abstract: Over the last twenty-five years, a set of influential studies has placed interest rates at the heart of analyses that interpret and evaluate monetary policies. In light of this work, the Federal Reserve's recent policy of "quantitative easing," with its goal of affecting the supply of liquid assets, appears to be a radical break from standard practice. Alternatively, one could posit that the monetary aggregates, when measured properly, never lost their ability to explain aggregate fluctuations and, for this reason, represent an important omission from standard models and policy discussions. In this context, the new policy initiatives can be characterized simply as conventional attempts to increase money growth. This view is supported by evidence that superlative (Divisia) measures of money often help in forecasting movements in key macroeconomic variables. Moreover, the statistical fit of a structural vector autoregression deteriorates significantly if such measures of money are excluded when identifying monetary policy shocks. These results cast doubt on the adequacy of conventional models that focus on interest rates alone. They also highlight that all monetary disturbances have an important "quantitative" component, which is captured by movements in a properly measured monetary aggregate.
Keywords: Monetary Policy; Interest Rates; Divisia Monetary Aggregates
JEL Codes: E51; E52; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Divisia money growth (E41) | Real GDP (E20) |
| Divisia money growth (E41) | Nominal prices (P22) |
| Contractionary monetary policy shock (E49) | Rising prices (P22) |
| Divisia measures (C43) | Improvement in SVAR fit (C32) |
| Federal funds rate (E43) | Inadequate capture of monetary policy effects (E19) |