M2 Growth Research Articles

Demand for money in the Euro area

We analyzed the stability of the money demand function using panel data from January 1999 through March 2006, covering the 11 EU countries (Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, Netherlands, Portugal, and Spain). First, we found that the money demand function was stable with respect to M3. This arguably supports the suitability of the ECB's focus on M3 money supply in its monetary policy. Second, the stability of the money demand function was recognized with respect not only to M3, but also to M1 and M2. Accordingly, the ECB's adoption of M1 or M2 growth as a reference value should probably be considered depending on how conditions change going forward.

U.S. Evolving Macroeconomic Dynamics: A Structural Investigation

We fit a Bayesian time-varying parameters structural VAR with stochastic volatility to the Federal Funds rate, GDP deflator inflation, real GDP growth, and the rate of growth of M2. We identify 4 shocks-monetary policy, demand non-policy, supply, and money demand-by imposing sign restrictions on the estimated reduced-form VAR on a period-by-period basis. The evolution of the monetary rule in the structural VAR accords well with narrative accounts of post-WWII U.S. economic history, with (e.g.) significant increases in the long-run coefficients on inflation and money growth around the time of the Volcker disinflation. Overall, however, our evidence points towards a dominant role played by good luck in fostering the more stable macroeconomic environment of the last two decades. First, the Great Inflation was due, to a dominant extent, to large demand non-policy shocks, and to a lower extent to supply shocks. Second, imposing either Volcker or Greenspan over the entire sample period would only have had a limited impact on the Great Inflation episode, while imposing Burns and Miller would have resulted in a counterfactual inflation path remarkably close to the actual historical one. Although the systematic component of monetary policy clearly appears to have improved over the sample period, this does not appear to have been the dominant influence in post-WWII U.S. macroeconomic dynamics.

FINANCIAL SECTOR WEAKNESS AND THE M2 VELOCITY PUZZLE

I. INTRODUCTION There has been a long-running debate over the usefulness of monetary aggregates as intermediate targets or information variables in the conduct of monetary policy. In the mid1970s the missing episode associated with M1 money demand was documented by Goldfeld (1976) and Judd and Scadding (1982). Passage of the Depository Institutions Deregulation and Monetary Control Act in 1980 and the Garn-St Germain Act in 1982 ushered in a period of financial deregulation, including interest-bearing checking accounts and money market deposit accounts. These innovations affected depositor behavior to such an extent as to make M1 unreliable as a target or indicator of policy. As a result, research efforts focused on M2 demand with initial evidence of stable short-run specifications for this aggregate, as in Small and Porter (1989). This issue remains timely, with the recent example of the European Central Bank debating whether to target a monetary aggregate or inflation in its implementation of monetary policy, as Svensson (1999) points out. In the United States, Feldstein and Stock (1994) argue that the Federal Reserve should use the M2 monetary aggregate as an intermediate target. On the other hand, a fair amount of work suggests that M2 is not reliable as either a target or an indicator of monetary policy. Friedman and Kuttner (1992) show that by the early 1990s the relationship between M2 and gross domestic producct (GDP) had weakened, and Estrella and Mishkin's (1997) work provides further support for this finding. Miyao (1996) presents evidence that a cointegrating M2 demand relationship broke down in the 1990s. As the link between M2 and GDP deteriorated, the forecasting ability of M2 money demand equations also suffered. The difficulties in forecasting M2 spurred a number of publications examining whether the deterioration in the M2 equation's forecasting ability was temporary, or whether more fundamental factors-such as flaws in the construction of the M2 aggregate, the opportunity cost, or both--were at work. Carlson and Parrott (1991) and Duca (1992) first argued that the existence of troubled thrifts and the length of time it took the Resolution Trust Corporation to resolve the thrifts' difficulties helped explain the weakness in M2. In particular, Duca found that the change in the volume of cumulated deposits at resolved thrift institutions accounted for a large part of the M2 weakness, although he suggested his findings be viewed cautiously because of the short time period of the analysis. In the same article, as well as in one subsequent to it, Duca (1995) also examined whether some of the weakness in M2 reflected substitution by households away from M2-type deposits and into bond and equity mutual funds. He found that adding a bond fund series to M2 reduced estimated M2 growth shortfalls. Orphanides et al. (1994), Carlson and Keen (1996), Feldstein and Stock (1996), and Mehra (1997) also present evidence that the unusual behavior of M2 was related to growth in stock and bond mutual funds. Koenig (1996a, 1996b) focused on the competitiveness problems of financial intermediaries in the face of tighter regulations and stricter capital standards. He proposed an alternative strategy for empirically modeling M2 by altering the opportunity cost measure to include a long-term Treasury bond rate. This addition substantially improved forecasts of M2 until 1995, when large prediction errors once again appear. Feinman and Porter (1992) and Mehra (1997) also attempted to explain recent M2 instability through alternative measures of the opportunity cost. Rather than refine the opportunity cost or redefine the M2 monetary aggregate, Carlson et al. (2000b) present consistent evidence of a cointegrating relationship through the 1990s between real M2, various scale measures, and an opportunity cost measure. This result is obtained after adjusting for periods of financial restructuring in the early 1990s, characterized by a sharp increase in bond and equity funds and a steep decline in small time deposits. …

Financial Sector Weakness and the M2 Velocity Puzzle

Deterioration in the link between M2 and GDP, along with large prediction errors, led the Federal Reserve to downgrade M2 as a reliable indicator in 1993. We argue that the financial condition of depository institutions was a major factor behind this unusual pattern of M2 growth. When constructing measures of M2 based on banks' and thrifts' capital positions, we obtain superior M2 forecasting results and a more stable relationship between M2 and the ultimate goals of policy. M2 may contain useful information when there are no major disturbances to depository institutions.

The Effects of Mortgage Prepayments on M2

Mortgage prepayments can contribute significantly to fluctuations in M2 growth rates. These mortgage prepayment effects are primarily driven by certain rules of mortgage-backed-security (MBS) insurers that require mortgage servicers to hold in M2-type deposits the prepayment proceeds due to MBS investors. This paper provides a methodology for estimating prepayment effects on M2. The effects are estimated separately for refinancing and home sales. The results indicate that excluding the mortgage prepayment effects from M2 produces smoother monthly growth rates. The stability of the relationship between money and GDP as measured by M2 velocity is also increased. Refinancing prepayments account for most of the prepayment effects on M2.

The Effects of Mortgage Prepayments on M2

Mortgage prepayments can contribute significantly to fluctuations in M2 growth rates. These mortgage prepayment effects are primarily driven by certain rules of mortgage-backed-security (MBS) insurers that require mortgage servicers to hold in M2-type deposits the prepayment proceeds due to MBS investors. This paper provides a methodology for estimating prepayment effects on M2. The effects are estimated separately for refinancing and home sales. The results indicate that excluding the mortgage prepayment effects from M2 produces smoother monthly growth rates. The stability of the relationship between money and GDP as measured by M2 velocity is also increased. Refinancing prepayments account for most of the prepayment effects on M2.

P-Star Model: A Leading Indicator of Inflation for Pakistan

The P-star inflation model is based on the long-term quantity theory of money and puts together the long-term determinants of the price level and the short-run changes in current inflation. The P-star model-based indicator has replaced the previous monetary policy procedures in a number of countries because it offers by far more information and predictive power than monitoring movements in money supply and the rate of monetary growth. In this paper we used the P-star model to calculate the leading indicator of inflation, and also to test the forecasting performance of the P-star model-based leading indicator of inflation. The results of the study show that compared to the simple autoregressive model and the M2 growth augmented model, the P-star model can be used to obtain the leading indicator of inflation in Pakistan because it has additional information about the future rate of inflation. Therefore, this paper provides a useful tool to the policy-makers to assess the future movement of inflation in Pakistan..

Role of eIF3 p170 in controlling synthesis of ribonucleotide reductase M2 and cell growth.

Translation initiation in eukaryotes is a rate-limiting step in protein synthesis. It is a complicated process that involves many eukaryotic initiation factors (eIFs). Altering the expression level or the function of eIFs may influence the synthesis of some proteins and consequently cause abnormal cell growth and malignant transformation. P170, the largest putative subunit of eIF3, has been found elevated in human breast, cervical, esophageal, and lung cancers, suggesting that p170 may have a potential role in malignant transformation and/or cell growth control. Our recent studies suggested that p170 is likely a translational regulator and it may mediate the effect of mimosine on the translation of a subset mRNAs. Mimosine, a plant nonprotein amino acid, inhibits mammalian DNA synthesis, an essential event of cell growth. The rate-limiting step in DNA synthesis is the conversion of the ribonucleotides to their corresponding deoxyribonucleotides catalysed by ribonucleotide reductase of which the activity is regulated by the level of its M2 subunit. It has been reported that inhibiting the activity of M2 also inhibits cell growth. To understand the relationship between protein and DNA synthesis and between p170 and cell growth control, we investigated in this study whether p170 regulates the synthesis of M2 and, thus, cell growth. We found that altering the expression level of p170 changes the synthesis rate of both M2 and DNA. Decreasing p170 expression in human lung cancer cell line H1299 and breast cancer cell line MCF7 significantly reversed their malignant growth phenotype. However, the overall [35S]methionine incorporation following dramatic decrease in p170 expression was only approximately 25% less than the control cells. These observations, together with our previous findings, suggest that p170 may regulate the translation of a subset mRNAs and its elevated expression level may be important for cancer cell growth and for maintaining their malignant phenotype.

Monetary policy rules in practice: evidence from Turkey

AbstractThis paper estimates a forward‐looking monetary policy reaction function of the Central Bank of the Republic of Turkey by considering the period from 1990:01 to 2000:10. When the spread between the interbank rate and depreciation rate of the local currency is taken as a policy tool, the empirical evidence suggests that the Turkish Central Bank responds to its foreign exchange reserves, output and M2 growth not the forward, current or lagged inflation. Copyright © 2003 John Wiley & Sons, Ltd.

Bond Market Inflation Expectations and Long-Term Trends in Broad Monetary Growth and Inflation in Industrial Countries, 1880-2001

Annual data for thirteen countries revealed three long up trends and down trends in inflation that were matched by growth rates in M2 and nominal GDP but not real GDP in each country and cross-country averages. Inflationary expectations as estimated by bond rates less real growth trends indicated little inflation expectation until the 1960s. Central banks had credibility to keep inflation low even during wartime. It was lost as inflation rose in the 1970s and regained only as inflation fell subsequently. Although relationships with annual data were not as reliable as with ten-year averages, annual inflation was significantly related to annual M2 growth and inflationary expectations which should not be ignored in central bank decision making.

Money Growth, Output Growth, and Inflation: Estimation of a Modern Quantity Theory

This paper develops a long‐run version of the quantity theory of money growth, real GDP growth, and inflation. Inflation rates, averaged for the years 1980‐1993, are computed for 81 countries. These cross‐section inflation rates are explained almost entirely by average M2 growth rates. In countries marked by high money growth and inflation, the estimated coefficients of M2 growth are strikingly close to one, strongly confirming the quantity theory. By contrast, in countries with relatively low money growth and inflation, the estimated money growth coefficient is only 0.69; the quantity theory offers a less complete explanation of inflation. Money growth and GDP growth are nearly orthogonal, consistent with long‐run monetary superneutrality. The quantity theory is a reliable model of inflation for most countries, but not for those experiencing slow long‐run money growth.

PREDICTING THE PROBABILITY OF A RECESSION WITH NONLINEAR AUTOREGRESSIVE LEADING-INDICATOR MODELS

We develop nonlinear leading-indicator models for GDP growth, with the interest-rate spread and growth in M2 as leading indicators. Since policy makers typically are interested in whether a recession is imminent, we evaluate these models according to their ability to predict the probability of a recession. Using data for the United States, we find that conditional on the spread, the marginal contribution of M2 growth in predicting recessions is negligible.

The Future of the Stock Market Channel in Egypt

The paper attempted to identify the degree of predictability of stock market returns from monetary variables and whether the stock market could be an alternate channel for transmitting monetary policy rather than the traditional money and credit channels. The empirical investigation was conducted using Bayesian VAR models consisting of four endogenous variables with four lags and a constant. Monthly data used in the estimation are the actively traded stocks HFI returns to represent market performance and inflation rate, as well as growth in both M1 and M2, and growth of credit to the private sector to represent the monetary stance. Empirical investigation showed, currently, the effectiveness of the credit channel in transmitting the monetary policy as well as the balance sheet channel. Nevertheless, the results provided evidence that in the future the stock market could be an effective channel in transmitting the monetary policy rather than the traditional credit channel.

What Was Behind the M2 Breakdown?

A deterioration in the link between the M2 monetary aggregate and GDP, along with large errors in predicting M2 growth, led the Board of Governors to downgrade the M2 aggregate as a reliable indicator of monetary policy in 1993. In this paper, we argue that the financial condition of depository institutions was a major factor behind the unusual pattern of M2 growth in the early 1990s. By constructing alternative measures of M2 based on banks? and thrifts? capital positions, we show that the anomalous behavior of M2 in the early 1990s disappears. Specifically, after accounting for the effect of capital constrained institutions on M2 growth, we are able to explain the unusual behavior of M2 velocity during this time period, obtain superior M2 forecasting results, and produce a more stable relationship between M2 and the ultimate goals of policy. Our work suggests that M2 may contain useful information about economic growth during periods of time when there are no major disturbances to depository institutions.

Historical U.S. Money Growth, Inflation, and Inflation Credibility

In this article, William G. Dewald, the retiring Research director at the Federal Reserve Bank of St. Louis, focuses on the longer-term monetary relationships in historical data. He uses charts of 10-year average growth rates in the M2 monetary aggregate, nominal GDP, real GDP, and inflation to show that there is a consistent longer-term correlation between M2 growth, nominal GDP growth, and inflation - but, not between such nominal variables and real GDP growth. The data reveal extremely long cycles in monetary growth and inflation, the most recent of which was the strong upward trend in M2 growth, nominal GDP growth, inflation during the 1960s and 1970s, and the strong downward trend since then. Data going back to the 19th century show that the most recent inflation/disinflation cycle is a repetition of earlier long monetary growth and inflation cycles in the U.S. historical record. Dewald also discusses a measure of bond market inflation credibility, which he defines as the difference between averages in long-term bond rates and real GDP growth. By this measure, inflation credibility hovered close to zero during the 1950s and early 1960s, but then rose to a peak of about 10 percent in the early 1980s. During the 1990s, the bond market has yet to restore the low inflation credibility, which existed before inflation turned up during the 1960s. Dewald concludes that the risks of starting another costly inflation/disinflation cycle could be avoided by monitoring monetary growth and maintaining a sufficiently tight policy to keep inflation low. An environment of credible price stability would allow the economy to function unfettered by inflationary distortions - which is all that can reasonably be expected of monetary policy, and is precisely what should be expected. 25 Tests of the Market's Reaction to Federal Funds Rate Target Changes Daniel L. Thornton In this article, Daniel L. Thornton tests several hypotheses about the market's reactions to changes in the Federal Reserve's federal funds rate target. Thornton finds that short-term rates and long-term rates responded differently to funds rate target changes when target changes were accompanied by a change in the discount rate. He presents evidence that the smaller response of long-term rates (in these instances) is due to the market revising its inflation outlook when the target is changed. Thornton finds no evidence that the size of the market's response varies with the size of the target change; however, he does find that the response to target changes is somewhat larger when the target change is the first change in a new direction. The reader is cautioned, however, that some of his results are based on a very small number of target changes.

Long-Run Money Demand and Inflation in China

This article reports on the stability of the long-run money demand functions for three definitions of money in China. Using annual data from 1951–1991, I have found that the long-run money demand functions using M0 and M2 exist and are stable throughout the sample period, which includes pre- and post-reform years. Further, it is found that the income elasticities of the real money demands for M0 and M2 are around 1.4–1.5 and 1.8–1.9. The results indicate that to control inflation under 10% in China, the targeted M2 growth rate should not exceed 28–29%.

Interest rates and the recent weakness in M2: An extension to the P ∗ model of inflation

A P ∗ model of changes in the deflator for nondurables and services consumption expenditures is estimated simultaneously with the error-correction model of M2 growth described in Koenig (1996). The inflation forecasts generated by the joint model have marginal predictive power for changes in the GDP deflator and exhibit none of the systematic bias which has plagued the original P ∗ formulation in recent years. Output-market slack is of little use in predicting changes in the consumption deflator, but there is evidence of a speed effect.

Long-term interest rates and the recent weakness in M2

The gap between long-term market interest rates and M2 deposit rates appears to be an important short-run determinant of M2 growth. The post-1990 weakness in M2 growth can be largely attributed to a widening of this yield gap and to a gradual acceleration in the trend rate of financial innovation. The empirical importance of the yield gap is robust across a variety of alternative money-demand specifications and is discernable even in sample periods which ended well before a breakdown in standard opportunity-cost measures became obvious.

Should bond funds be added to M2?

In the early 1990s, M2 growth has been weaker than estimated while bond mutual funds have grown rapidly. This study assesses whether adding bond funds to M2 would yield a monetary aggregate that is more explainable using a standard error correction model of money with and without modifications for bond interest rate and thrift resolution effects. Results indicate that it is important to net out institutional and IRA/Keogh assets from bond funds (as is done for M2) and that adding such a bond fund series to M2 results in an aggregate that is somewhat more explainable than M2.

Adding bond funds to M2 in the P-Star model of inflation

During the early 1990s, M2 growth has been unusually weak and the P-Star model has underpredicted inflation; at the same time, bond funds have grown rapidly. We find that the P-Star model performs well recently when M2 is adjusted for bond funds.