Inside money and real output: A reinterpretation

Abstract

The interpretation of correlations between inside money innovations and real output is examined. Such correlations could reflect a “real business cycle” in which money responds to new information concerning future real disturbances, but the same correlations could arise from the anticipated real effects of future monetary policy actions. Correlations between inside money and real output are thus equally consistent with the hypothesis that business cycle fluctuations are caused by monetary policy. Correlations between inside money and outside money might allow us to reject the monetary interpretation, but if policy happens to be correlated with real sector disturbances in a particular way, the two hypotheses are observationally equivalent. Monthly postwar U.S. data is consistent with either hypothesis: Inside money innovations could represent anticipated policy shocks. Alternatively, inside money innovations could represent real shocks if policy is correlated with real shocks in a particular way.