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short essays and reports on the economic issues of the day
2009 ■ Number 21

Can Monetary Policy Affect GDP Growth?
Yi Wen, Assistant Vice President and Economist
he Fed has taken unconventional measures over
the 2-quarter horizon), money base growth is slightly negthe past 18 months to contain the financial crisis
atively associated with GDP growth. However, around the
and limit ramifications for the broader economy.
typical business cycle horizon (say within the horizon of 8
These measures have resulted in an extraordinary increase
to 16 quarters or 2 to 4 years), money base growth has a
in reserve balances at commercial banks—which is a key
significant positive relation with GDP growth. In particucomponent, along with currency, of the monetary base.
lar, at the 12-quarter horizon, for every 1 percent increase
in money base growth, there is about 0.4 percent correthe current programs proposed by the Fed should increase
sponding increase in GDP growth. Such a positive relation
reserves by about $2.285 trillion—nearly a 300-fold increase
disappears again in the very long run beyond the typical
compared with the $8 billion level in early September 2008.1
business cycle, perhaps because in the long run money
Many analysts have raised concerns that the increased
growth is inflationary, which leads to higher prices and
reserves will ultimately increase inflation and the price
lower output.
level. One might also expect such an enormous increase in
reserves to stimulate aggregate output, thereby mitigating
We merely want to see whether,
the adverse effects of the financial crisis on the economy.
historically, fast growth of the
But can such an impact be estimated quantitatively?
Historically, we can look at postwar U.S. data and see
monetary base has been associated
how much gross domestic product (GDP) growth can be
with faster growth of real output.
associated with or forecasted by the growth rate of the
monetary base. Note that such a statistical association is not
Therefore, historical data tell us that if there is any pos“causal.” We merely want to see whether, historically, fast
growth of the monetary base has been associated with faster
itive association between money growth and GDP growth,
growth of real output. One approach is to use an analysis
the impact comes about 3 years after an initial acceleration
of base growth. Such a long lag suggests that an observed
that captures the impact of current and past increases of
and expected increase in the monetary base may not have
the monetary base on current GDP growth, taking into
consideration the influence of the history of
GDP on its own future growth. This estimation can be done at different horizons using
Impact of Monetary Base on GDP Growth
statistical tools.
Estimated Impact
The chart shows the association of mone1.0
tary base growth with GDP growth at different horizons, where the horizontal axis is the
number of quarters and the vertical axis indi0.0
cates the estimated impact of money base
growth on output growth. The solid line is
the estimation and the dashed lines are one–1.0
standard-error bands, which quantify the
12 16 24 256
uncertainty of the estimation. The chart
indicates that in the very short run (say at


Economic SYNOPSES

Federal Reserve Bank of St. Louis

a very large effect on output growth. Of course, the big
caveat is that there has never been such an extraordinary
increase in base growth. Therefore, the evidence based on
historical data is not conclusive, but only a rough guide. ■


Taylor, John B. “Monetary Policy and the Recent Extraordinary Measures
Taken by the Federal Reserve.” Testimony before the Committee on Financial
Services, U.S. House of Representatives, February 26, 2009;

Posted on April 24, 2009
Views expressed do not necessarily reflect official positions of the Federal Reserve System.