TheCase of t he Missing Money THE RELATION between the demand for money balances and its determinants is a fundamental building block in most theories of macroeconomic behavior. Since it is also a critical component in the formulation of monetary policy, it is not surprising that the money-demand function has been subjected to extensive empirical scrutiny. The evidence that emerged, at least prior to 1974, suggested that only a few factors (essentially income and interest rates, with due allowance for lags) were needed to explain adequately the quarterly movements in money demand. There were episodes that, during their course, gave the impression that the moneydemand function was shifting. On the whole, however, in the time allowed for final data revisions by a "wait and see" attitude, the apparent puzzles tended to clear up.' As has been widely documented,2 the U.S. economy is once again experiencing an apparent shift in the money-demand function. In particular, when money-demand functions that have been successfully fitted to pre-1974 data are extrapolated into the post-sample period, they consistently and significantly overpredict actual money demand. Furthermore, as the economy has moved into the upturn phase of the business cycle, the forecasting errors have mushroomed. While one might hope that subsequent data revisions could "solve" the present puzzle, this sanguine attitude seems unwarranted for a variety of reasons.First, the sheer magnitudes of the forecasting errors suggest that im-1. Such econometric "benign neglect" begs the real problems facing the monetary authorities, who are striving to make reasonable policy choices during these episodes.2. See, for example, Jared Enzler, Lewis Johnson, and John Paulus, "Some Problems of Money Demand," BPEA, 1:1976, pp. 261-80. 684Brookings Papers on Economic Activity, 3:1976 plausibly large data revisions would be required to explain current developments with equations of the sort I reported earlier. Second, the large forecasting errors for 1974-76 coincide with unusual conditions. Among other things, that period saw the most severe recession of the postwar era; an extended bout of double-digit inflation; the highest interest rates in many years; and many institutional changes in the financial structure. While the failure of an empirical macro relationship under such extreme conditions is perhaps not surprising, it should at least prompt the question of whether the specification was adequate to cope with them. In short, a reassessment of the current state of knowledge on the demand for money balances seems called for. OutlineThe plan of the paper is as follows. The next section reviews the forecasting experience with "conventional" money-demand equations, documenting the source and magnitude of the recent errors. It also considers whether the deterioration in the money-demand equation observed in the current cyclical episode had any counterpart in previous periods of recession and recovery. The second section reexamines the specification of the conventional equ...

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The Financial Valuation of t he Return t o Capital THE BEHAVIOR of the U.S. stock market over the past decade has puzzled both academic and lay observers. Recent experience casts doubt on the traditional belief that common stocks are an ideal hedge against inflation. Comparisons of the cyclical peak years of 1959, 1968, and 1979 are revealing. The total nominal return from investing in the market portfolio of common stocks has a geometric average of just 4.7 percent a year for the 1968-79 period, far less than the rise in consumer prices of 7.0 percent for the same period. By contrast, stock returns from 1959 to 1968 averaged 9.3 percent while prices rose only 2.1 percent a year. In real terms, stock prices at the end of 1978 (as represented by the Standard & Poor's 500) were about half of their historic peak level of 1968. For no other ten-year period, including the Great Depression, have stocks performed

Where Do We Stand? THE BROOKINGS PANEL on Economic Activity for the past ten years has mirrored much of the exciting theory and empirical work in open-economy macroeconomics. In the spirit of Brookings, the papers have explored what issues openness raises for macroeconomic management. The range of interests has been quite broad, beginning with William Branson's "new view of international capital movements" and including Marina Whitman's dismissal of "global monetarism" and many of the topics of the day from trade equations and oil to commodity booms, debt, and portfolio selection.' The questions have been similar-how much independence there is for macroeconomic policy in an interdependent world; how important monetary factors are; or how can the interest rate be kept lower than the market will bear. The papers have emphasized the evolution of open-economy macroeconomics from the structure of the 1960s-the Mundell-Fleming model-to a framework better suited to the analysis of inflation, expectations, and portfolio substitution. This paper maintains the tradition of asking how international interdependence has impinged on macroeconomic variables and policy options. The paper takes as its frame of reference the experience with floating ex-I am grateful for comments from members of the Brookings panel and from Stanley Fischer. Robert E. Cumby made many suggestions and provided generous research assistance. Financial support was provided by a grant from the National Science Foundation. 1.