Finance and Economics Discussion Series - Interest Rates and M2 in an Error-Correction Macro Model (Paperback)

With annual data, real M2 is shown to have a surprisingly strong contemporaneous and leading relationship to GDP, that is robust to the inclusion of other explanatory variables. When combined and tested with parsimonious error correction equations for money demand, price determination, and a monetary policy reaction function, an overall macroeconometric model is revealed with an unusually good fit aside from a velocity shift adjustment needed for the early 1990s and better inflation performance than expected of late. A regime shift is evident in the stronger response of the Federal Reserve to inflation in the 1980s than in the previous two decades.