Direct effects of base money on aggregate demand: theory and evidence

Working papers set out research in progress by our staff, with the aim of encouraging comments and debate.
Published on 11 October 2000

Working Paper no. 122
By Edward Nelson 

Meltzer (1999a) shows that real monetary base growth is a significant determinant of consumption growth in the United States, controlling for the short-term real interest rate. In this paper, I show that the same property of base money holds for total output (relative to trend or potential) in both the United States and the United Kingdom. The standard optimising IS-LM model cannot account for this result, but I show that it can once the long-term nominal interest rate is included in the money demand function. Because the long-term real rate matters for aggregate demand, the presence of the long-term nominal rate in the money demand function increases the effect of nominal money stock changes on real aggregate demand when prices are sticky.

PDFDirect effects of base money on aggregate demand: theory and evidence

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