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Money-Multiplier Shocks

Luca Benati () and Peter Ireland ()

No 933, Boston College Working Papers in Economics from Boston College Department of Economics

Abstract: Shocks to the M1 multiplier–in particular, shocks to the reserves/deposits ratio–played a key role in driving U.S. macroeconomic fluctuations during the interwar period, but their role in the post-WWII era has been almost uniformly negligible. The only exception are shocks to the currency/deposits ratio, which played a sizeable role for inflation and M1 velocity. By contrast, shocks to the multiplier of the non-M1 component of M2, which had been irrelevant in the interwar period, have played a significant role in driving the nominal side of the economy during the post-WWII period up to the collapse of Lehman Brothers, in particular during the Great Inflation episode. During either period, the multiplier of M2-M1 has been cointegrated with the short rate. The monetary base had exhibited a non-negligible amount of permanent variation during the interwar period, whereas it has been trend-stationary during the post-WWII era. In spite of the important role played by shocks to the multiplier of M2-M1 during the post-WWII period, we still detect a non-negligible role for a nonmonetary permanent inflation shock, which has the natural interpretation of a disturbance originating from the progressive de-anchoring of inflation expectations which started in the mid-1960s, and their gradual re-anchoring following the beginning of the Volcker disinflation.

Keywords: Money multiplier; money demand; Lucas critique; structural VARs; unit roots; cointegration; long-run restrictions. (search for similar items in EconPapers)
JEL-codes: E31 E32 E41 E42 E51 E52 E58 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-his, nep-mac and nep-mon
Date: 2017-08-01
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