W. Douglas McMillin

Federal deficits and short-term interest rates

Abstract This paper analyses empirically, using multivariate Granger-causality tests, the effects of federal deficits on short-term interest rates. Four deficit measures—the national income accounts measure, a flow-of-funds measure, the cyclically-adjusted deficit, and the change in the market value of privately held federal debt—are separately considered. Additional variables suggested by theory as important determinants of interest rates are considered along with the deficit measures. Quarterly data for the period 1957–1984 are employed in the tests. The multivariate tests suggest that none of the deficit measures Granger-cause the interest rate.

Monetary shocks, the exchange rate, and the trade balance

Abstract This paper investigates the response of the exchange rate and the trade balance to monetary policy innovations for the US economy during the period 1973:01–1993:12. The empirical findings indicate that contractionary monetary policy shocks lead to transitory appreciations of the real and the nominal exchange rate. Exchange rate appreciations that are caused by a temporary contractionary shock to monetary policy are correlated with a short-lived improvement in the trade balance which is then followed by a deterioration, giving support to the J -curve hypothesis.

A Multivariate Time Series Analysis of the United States Aggregate Production Function

This study examines the effects of hours of work per unit of private sector capital, the relative price of energy, government capital per unit of private sector capital, and inflation on private sector output per unit of capital in the U.S. over the period 1952–90. A small vector autoregressive model that comprises the variables typically employed in single-equation estimates of the aggregate production function is used. Variance decompositions and cumulative impulse response functions indicate that hours of work per unit of private sector capital, the relative price of energy, and the inflation rate have significant effects on private sector output per unit of capital over the 1952–90 period. However, there is no evidence of a significant effect for government capital per unit of private capital. An historical decomposition that begins in 1973 with the emergence of a “productivity slump” and continues through 1990 indicates that shocks to hours of work per unit of capital, the relative price of oil, and inflation appear important in explaining output per unit of capital but shocks to government capital are not important.

The Velocity of M1 in the 1980s: Evidence from a Multivariate Time Series Model

The velocity of M declined in the 1980s after an upward trend over the previous twenty years. This apparent break in the process generating velocity was an important consideration in the Federal Reserves deemphasis of M as an intermediate target in 1982. Discussion of the behavior of velocity has focused upon whether the process generating velocity underwent a shift, perhaps due to the financial innovation and deregulation in the 1980s, or whether the behavior of velocity merely reflects the underlying variability in its determinants. Tatom [34], Darby et al. [7], Stone and Thornton [33], and Rasche [30] provide summaries of this debate. No consensus has emerged on whether the process generating the velocity of M 1 shifted after 1982. The aim of the present paper is to analyze the behavior of velocity before and after 1982. The approach taken here is quite different from the traditional method of analyzing velocity which relies upon single-equation estimates of velocity or money demand functions. A vector autoregressive (VAR) model that contains the income velocity of M1 and its key economic determinants (income, interest rates, inflation, and money growth variability) is estimated using quarterly data for the period 1961:1-1981:4. The adequacy of this model is evaluated by calculating variance decompositions. A Monte Carlo simulation technique similar to that described in Doan and Litterman [8] is used to compute standard errors for the variance decompositions. This allows a judgement as to the significance of the response of velocity to its economic determinants. The effects of these variables on velocity for the period 1982:1-1988:4, the period of velocitys unusual behavior, are estimated through computation of historical decompositions. Formal stability tests are also performed to determine if there was a change in the process generating velocity after 1982.

The Short Run Impact of Fiscal Policy on the Money Supply

Surprisingly little research effort has been devoted to the study of the impact of fiscal variables on the money supply. Furthermore, the limited amount of empirical evidence is often ambiguous and contradictory. Both Froyen [10] and Barro [1] find some evidence of a positive relationship between fiscal expansion and either the money supply or a monetary policy variable, implying that the monetary authorities tend to accommodate fiscal policy. Some evidence of a negative relationship is found in studies by Wood [27], Friedlaender [9], Gordon [13], and Cacy [3]. This implies that monetary actions tend to offset, rather than accommodate, expansionary fiscal actions. The absence of stronger empirical support for a positive fiscal policy-money supply relationship seems surprising in view of the frequently heard argument-often associated with the monetarists, as in Fand [6] and Buchanan and Wagner [2]-that large fiscal deficits typically result in substantial increases in the monetary aggregates. Exactly how this process is supposed to work is not always clear, but perhaps a typical explanation is outlined by Francis [8]. The Federal Reserve is seen as having an over-riding concern with stabilizing interest rates, so that fiscal expansion leads more or less mechanically to an increase in the money supply. An expansionary fiscal policy action results in aon budget deficit which must be financed through issuance of government securities; the sale of these securities to the private sector puts upward pressure on market interest rates; this upward pressure is countered by Federal Reserve purchases of outstanding government securities, thereby monetizing, at least in part, the debt issued to finance the deficit. But to consider interest rate stabilization-or financial market stability-as the single goal of the Federal Reserve would clearly be extreme. Previous studies which have estimated policy reaction functions for the Federal Reserve-including those of Wood [27], Friedlaen-

The Effects of Monetary Policy Shocks: Comparing Contemporaneous versus Long-Run Identifying Restrictions

This study compares the effects of monetary policy shocks on the macroeconomy using four different procedures for identifying policy shocks that use contemporaneous restrictions and a procedure that uses long-run restrictions. Impulse response functions are computed using the same vector autoregressive (VAR) model and sample period. The comparison is done for a model that includes only a short-term interest rate and for a model that adds a long-term rate as well. Sources of differences in the magnitude of effects across identification schemes are examined.

The impact of budget deficits in the interwar period

Abstract Five- and six-variable vector autoregressions are estimated, and the effects of deficits on interest rates, money, production, and prices are analyzed through the computation of likelihood ratio tests, variance decompositions and impulse response functions. A Monte Carlo simulation technique is used to estimate standard errors. Systems are analyzed for two alternative time periods that have been used to represent the interwar period. The study concludes that July 1922–June 1938 is the more appropriate period for analyzing deficits. Our results indicate that deficits have no major effects on the non-fiscal variables in this period.

Estimating the effects of monetary policy shocks: does lag structure matter?

This paper examines the implications of lag structure for estimating the effects of monetary policy shocks in a VAR. A symmetric lag structure in which all variables have the same lag length and an asymmetric lag structure in which the lag length differs across variables but is the same for a particular variable in each equation of the model are examined. This is important in light of the fact that the true lag structure is generally not known. Four commonly used identification schemes are employed to identify monetary policy shocks. Monte Carlo simulations strongly indicate that the lag structure of a VAR model does matter when assessing the quantitative effects of monetary policy shocks. Given the inherent uncertainty about the true lag structure in practice, it is thus important that one compare the impulse response functions from both symmetric lag and asymmetric lag VARs in assessing the effects of monetary policy shocks.

Monetary policy and bank portfolios

Abstract This paper examines the existence of the bank lending channel for monetary policy over the period 1973:1–1994:11. The results are consistent with a bank lending channel when the Bernanke-Blinder model is extended to include commercial paper and the spread between the loan and commercial paper rates. The results are robust to alternative monetary policy measures. However, stability tests indicate instability over the nonborrowed reserves operating regime. When the estimates excluded data for this period, there was little evidence of systematic movement in bank loans in the direction predicted by the bank lending channel.

Evaluating Monetary Policy Options

We present a procedure for evaluating ex ante the effects of alternative paths of a monetary policy tool (the federal funds rate in our illustrations) on output and the price level within a variant of a widely used vector autoregressive model of the U.S. economy. This exercise is a supplement to, or even an alternative to, analysis that relies on a particular structural model. Illustrations of the method are provided by evaluating the effects of changes in the funds rate target. Additionally, the Taylor rule is used to generate target funds rates for different target inflation rates, and the effects of these are evaluated.