Unanticipated Money Growth and GDP: Evidence from Korea

Abstract

Nominal and real macroeconomic variables are traditionally linked by the expectational Phillips curve. There is evidence that changes in employment and output result from unanticipated changes in money stock and inflation. Unfortunately, expectations about money stock and prices are not observed. Previous literature estimates them using static models with a limited number of lagged variables. The possibility of omitting important factors or lags is substantial. This study uses a state-space model where expectations about money stock depend on the long history of macroeconomic variables and their distributions. Priors about the growth rate are updated using a Kalman filter method. Quarterly data on the Korean economy is used to infer the one-period-ahead expected money stock, price level and price of oil, and to estimate the relationship between the unanticipated money stock and growth of national output. The study controls for the determinants of aggregate supply and demand, money stock and inflation. The results show that a one-percent shock to Korea’s money stock increases national demand by 0.02%. The study confirms validity of the expectational Phillips curve between shocks to unemployment and the unexpected inflation rate.