Money, Real Interest Rates, and Output: A Reinterpretation of Postwar U.S. Data

Abstract

This paper reexamines both monthly and quarterly U.S. postwar data to investigate if the observed comovements between money, real interest rates, prices and output are compatible with the money--real interest--output link suggested by existing monetary theories of output, which include both Keynesian and equilibrium models.The major empirical findings are these; 1) In both monthly and quarterly data, we cannot reject the hypothesis that the ex ante real rate is exogenous, or Granger-causally prior in the context of a four-variable system which contains money, prices, nominal interest rates and industrial production.2) In quarterly data, there is significantly more information contained in either the levels of expected inflation or the innovation of this variable for predicting future output, given current and lagged output, than in any other variable examined (money, actual inflation, nominal interest rates, or ex ante real rates). The effect of an inflation innovation on future output is unambiguously n eo t4The first result casts strong doubt on the empirical importance of existing monetary theories of output, which imply that money should have a causal role on the ex ante real rates. The second result would appear incompatible with most demand driven models of output.In light of these results, we propose an alternative structural model which can account for the major dynamic interactions among the variables.This model has two central features: i) output is unaffected by money supply;and ii) the money supply process is motivated by short-run price stability. In the newer equilibriuni theories, the connection between money, perceived real

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