William E. Gibson

Interest Rates and Monetary Policy

This paper investigates the empirical operation of some recognized theoretical effects of the money stock on market rates of interest. The analysis covers the period since World War 11, the period for which extensive quarterly and monthly data are available. There is a widespread belief among economists that an increase in the money stock lowers interest rates.1 This conclusion seems to follow from the liquidity-preference relation between the level of interest rates and the quantity of money demanded. As stated by Tobin (1947, p. 126):

The Lag in the Effect of Monetary Policy on Income and Interest Rates

I. Introduction, 288. — II. Monetary changes, interest rates, and national income, 288. — III. Lag in effect of monetary policy, 291. — IV. Measurement of effects of monetary policy changes, 292.

The Sensitivity of Interest Rates to Changes in Money and Income

Changes in interest rates may be attributed to changes in the supply schedule of funds, changes in the demand schedule, or changes in both schedules. Since interest rates link the financial and real sectors of the economy and thus transmit the major thrust of central bank actions to the ultimate targets of monetary policy, it is important to identify properly the causes underlying changes in rates. An increase in rates resulting from an upward shift in the demand fot funds has substantially different implications for the course of economic activity than an equal rise attributable to a downward shift in the supply of funds. This paper conducts tests to determine whether postwar changes in interest rates have resulted primarily from changes in the demand for funds or in the supply of funds. As a first approximation, interest rates can be assumed to be affected on the supply side primarily by the supply of money and on the demand side primarily by aggregate income or output. We can test the relative strengths of money and output on rates by including them both as explanatory variables in one equation1: