The mechanisms governing the relationship of money, and interest rates to the business cycle are the most studied and most disputed topics in macroeconomics. In this paper, we first document key empirical aspects of this relationship. We then ask how well three benchmark rational expectations macroeconomic models-a real business cycle model, a price model and a effect model-account for these central facts. While the models have diverse successses and failures, none can account for the fact that real and nom- inal interest rates are inverted leading indicators of real economic activity. That is, none of the models captures the post-war U.S. business cycle fact that a high real or nominal interest rate in the current quarter predicts a low level of real economic activity two to four quarters in the future. I. Introduction THE positive correlation of monetary aggregates and real economic activity over the course of many business cycles is a key empirical fact about the U.S. economy. Indeed, the dynamic dimension of this covariation is so strong and stable that a monetary variable has long been included in the Commerce Department's Index of Leading Economic Indica- tors. While this pattern of cyclical comovement is widely agreed upon, its interpretation is not. Some macroeconomists view money as purely passive, with a positive response to varying levels of economic activity producing the positive correlation. Others view changes in the quantity of money as an important, perhaps dominant, source of economic fluctua- tions. Frequently, the real of monetary changes are suggested to arise from frictions in commodity, labor or financial markets. In economic theories that describe the influence of these frictions, the transmission mechanism from monetary changes to real activity is typically viewed as involving interest rates and the price level. The primary goal of this paper is to evaluate three models that explain the link between money, prices, interest rates and the business cycle. We do this in three steps. First, we docu- ment the cyclical behavior of these variables in the United States over the postwar period. Second, we construct three quantitative rational expectations models of macroeconomic activity: (i) a real business cycle model with endogenous money; (ii) a model of commodity market frictions with mon- etary non-neutralities arising from gradual adjustment of goods prices; and (iii) a model of financial market frictions with monetary non-neutralities arising from gradual adjust- ments of portfolios. Finally, we compare the models' predic- tion for the business cycle behavior of money, and interest rates with the data. In exploring the predictions of these models, we take the stock of money to be one of several exogenous variables in the system. All of our models are capable of generating a forecasting role for money relative to real economic activity, similar to that found in the U.S. data. In the real business model, monetary changes can forecast real activity because productivity is related to many underlying sources of shocks and because these real shocks also affect the money stock. In the models with sticky prices and liquidity effects (short-hand names for the models with frictions in the com- modity and financial markets), monetary changes have an additional direct positive effect on aggregate output. The outline of the paper is as follows. Section II describes the data and documents its business cycle characteristics. Section III outlines the three macroeconomic models and develops the particular quantitative versions of the models used in our analysis. Our main empirical results are pre- sented in section IV, and section V summarizes our results and concludes.