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BREE years after its enactment, controversy still surrounds the Economic Recovery Tax Act of 1981 (ERTA) and its successor, the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA). On the one hand, the Reagan administration claims that the 1981 tax reductions substantially increased U.S. business investment and contributed to the strong recovery from the 1981-82 recession'. On the other hand, some commentators argue that the tax reductions have failed to increase business investment. 2 Moreover, other critics

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Goethe: "Let us live in as small a circle as we will, we are either debtors or creditors before we have had time to look around." (Elective Affinities, Bk. II, Ch. 4) R.ECENTLY, many critics of monetary policy, and some monetary policymakers as well, have asserted that the links between monetary aggregates and national economic policy variables-that is, GNP, inflation and real economic growth-have been severed by a host offinancial and credit market innovations. If these critics are correct, then a monetary policy based on targeting the growth of a monetary aggregate would become increasingly ineffective and inappropriate, as credit arrangements are substituted for monetary payments. 1 The purpose of this article is to provide a theoretical framework in which to assess these claims The author, an associate professor ofeconomics at The Pennsylvania State University, isa visiting scholaratthe Federal Reserve Bank of St. Louis. 'For examples, see Neil C. Berkman, "Abandoning Monetary Aggregates," in Controlling Monetary Aggregates Jil, proceedings ofaconference sponsored by the Federal Reserve Bank of Boston (October 1980), pp. 76-100; Benjamin M. Friedman, "The Relative Stability of Money and Credit 'Velocities' in the United States: Evidence and Some Speculations," NBER Working Paper No. 645 (March 1981); Anthony M. Solomon. "Financial Innovation and Monetary Policy" (remarks before the Joint Luncheon of the American Economic and American Finance Associations, December28, 1981); James M. Tobin, "Inflation," in Encyclopedia of Economics, Douglas Creenwald, ed. (McGraw-Hill, 1982), pp. 510-23. Forthe contraryposition-i.e., that monetary policy should be undertaken through effective control ofa monetary aggregate-see Milton Friedman, "Mone

ORE than a decade has passed since the demise of the Bretton Woods system of fixed exchange rates. 1 Because ofits demonstrated inability to provide for the institutional adjustment of exchange rates necessary to incorporate change, there is general agreement that the Bretton Woods system, under which world trade was organized from 1945 to 1971, could not have been maintained. 2 Moreover, the viability of the system of floating exchange rates is buttressed by both a massive

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ENCE the late l970s, theoretical explanations of exchange rate deternunation have emphasized the asset approach rather tItan the expenditure approach.' Most of the empirical research applying the asset models of exchange rate detern malion also subsume the efficient market hypothesis. In this article, we test three efficient niarke I hypotheses bearing on forward exchange rates: Fl rst, are forward rates unbiased forecasts of future spot exchange rates? Second, does ''news'' in particular iinanti ci pated changes in nominal or real interest differentialsexplain for

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