Two essays on money supply growth, inflation, and interest rates

Masoud Moghaddam

ISU General Staff Papers from Iowa State University, Department of Economics

Abstract: Models recently developed under rational expectations reached a revolutionary conclusion that the anticipated money stock growth rate does not matter even in the short-run. Therefore, to affect real variables such as the real gross national product, unemployment, and the real interest rate the change in the rate of growth of the money supply must come as a surprise to the general public, i.e., the unanticipated portion of the money supply growth rate (UM(,t)) has real effects;Interest rates in the bonds markets are most sensitive to a change in the money supply growth rate. Furthermore, the efficiency of the bond markets implies that an increase in (UM(,t)) creates a liquidity effect, which is associated with a drop in interest rates. Correspondingly, an anticipated money supply growth (AM(,t)) has price expectational effects, without any real effects;The statistical results of part one are supportive of the two different directional effects associated with anticipated and unanticipated money supply growth rates. Accordingly, the answer to the question of whether anticipated monetary policies matter, depends mainly upon the choice of particular time series data;The Darby effect, which is an extension of the Fisherian hypothesis, implies that in the presence of income taxes, the nominal interest rate must increase more than the rate of increase in the expected rate of inflation. The reason for the Darby effect is that interest income received by a lender is subject to income taxes, and interest paid by a borrower is tax-exempted. The empirical tests of the Darby effect over the past decade concluded either the nonexistence, or a weak existence of the Darby effect over the sample period. However, Ayanian's study completed in 1983, reported a significant Darby effect for the sample period 1952-1979;The statistical results of part two imply that the finding of the Darby effect, in the context of Ayanian's model, is subject to impure autocorrelation. Therefore, Ayanian's model is misspecified and is not a good candidate for the empirical testing of the Darby effect. Also, when Ayanian's model is extended to August 1983, and corrected for pure auto-correlation, the nonexistence of the Darby effect is witnessed.

Date: 1984-01-01
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