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Review
Vol. (is, No. 8




October 198(S

T h e A n d e rse n -Jo rcla n A p p ro a c h a f te r
Y e a rly 2 0 Y ears

9 I he M onetary-Fiscal Policy Debate and
the Andersen-Jorclan Equation
18 A M onetarist Model for E con om ic
Stabilization: Review and Update
29 M onetary and Fiscal Actions: A Tfest of
Their Relative Im p o rtan ce in
Econom ic Stabilization
4.") A M onetarist Model for E con om ic
Stabilization

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F e d e ra l R e se rv e B ank of St. L ouis
Review
O ctob er 1986

In This Issue . . .




In M em oriam
Leonall C. Andersen
1924-1985
T h is issu e o f th e Review is d ed ica ted to th e m em ory o f L eonall C. A nd ersen, w ho
d ied on O cto b er 2 7 ,1 9 8 5 . A ndy’s involvem ent w ith an d co n trib u tio n to ec o n o m ics
sp an n ed a perio d o f th ree d ecad es, divided alm o st equally b etw een aca d em ia
an d th e F ed eral Reserve Bank o f St. Louis. He began h is ca re e r in 1955 as an
assistan t p ro fesso r o f e c o n o m ics at St. O laf C ollege in N orthfield, M in n eso ta; at
th e tim e o f h is d eath , h e w as P rofessor o f E co n o m ics at G ustavus A dolphus
College in St. Peter, M in n esota. F o r 16 y ears, how ever, from August 1962 to August
1978, h e w as a m e m b er o f th e R esearch D ep artm en t at th is Bank, w h ere h e
co n trib u te d sign ifican tly to re se a rc h in m o n etary issu es.
A ndy’s best-kn ow n co n trib u tio n s, b o th to th e e c o n o m ics p ro fessio n at large
an d to th e rep u tatio n o f th e F ed eral Reserve B ank o f St. Louis in m o n etary p o licy
m atters, ap p eared in tw o articles in th is Review. “M onetary an d F isca l A ction s: A
T est o f T h e ir Relative Im p o rta n ce in E co n o m ic Stab ilizatio n ,” co -a u th o red w ith
Jerry L. Jo rd an , w as p u b lish ed in N ovem ber 1968; it gave rise b o th to th e w ellknow n A n d ersen -Jo rd an (or St. Louis) eq u atio n an d to th e u n en d in g con troversy
abou t its m ethod ology an d resu lts. “A M on etarist M odel for E co n o m ic Stabiliza­
tio n ,” co -a u th o red w ith K eith M. C arlson, w as p u b lish ed in April 1970; it devel­
op ed a sm all m o n etarist m a c ro e co n o m ic m od el that h as b ee n u sed for policy
p u rp o ses at th is Bank an d elsew h ere. To h o n o r Andy, w e are rep rin tin g th e se
original articles, along w ith ev aluations by h is co -a u th o rs an d o th ers, o f th e ir
co n tin u in g im p o rta n ce an d relev ance. T h e se w ill b e follow ed by a b rief b io g ra p h i­
cal sk etch an d a se le c te d b ibliograph y o f A ndy’s im p o rtan t co n trib u tio n to
eco n o m ics.
*

*

*

In th e first article in th is Review, “T h e A n d ersen -Jo rd a n A p p ro ach after Nearly
20 Y ears,” Jerry L. Jo rd a n d escrib es th e th eo retica l an d p o licy -related issu e s o f th e
late 1960s th at led h e an d Andy to develop w h at is n ow called th e A n d ersen Jo rd a n ap p ro ach . First, th e y view ed th e ir re sea rch as a seq u el to w ork by
Friedm an-M eiselm an , B ru n n er-M eltzer an d o th ers w ho h ad d em o n stra ted th e
gen eral p o te n ce o f m o n etary p o licy a ctio n s. In ad d ition , th e ir re se a rc h attem p ted
to an sw er a p o licy issu e o f vital c o n c e rn in 1968: w h eth er th e expansive m o n etary
stim u lu s o r th e restrictive fiscal p o licy a ctio n s th e n in p la ce w ou ld have th e
p red o m in an t im p act on sp en d in g. Jo rd a n th e n d iscu sse s w hy, in h is o p in io n , th e
A n d ersen -Jo rd an m e th o d an d resu lts w ere co n sid ere d so con trov ersial. Finally,
after review ing so m e rea so n s often cite d for th e alleged d em ise o f m o n eta rism in
re cen t y ears, Jo rd a n co n c lu d e s th at th e A n d ersen -Jo rd an a p p ro a ch en d u res;
3

In This Issue . . .
specifically, th e sing le-equ ation , red u ced -fo rm m eth o d olo gy em p loy ed to asse ss
th e effects o f different p o licy a ctio n s on th e eco n o m y rem a in s u sefu l today.
In the se c o n d article in this issue, D allas S. B atten an d D aniel L. T h o rn to n
ex am in e th e con troversy th at em erged follow ing th e p u b lica tio n o f th e 1968
A n d ersen -Jo rd an article (see rep rin t o f th e original article b eg in n in g on p. 29).
A nd ersen an d Jo r d a n ’s b a sic finding — th at m o n etary a ctio n s have a lastin g
im p act on ec o n o m ic activity w hile fiscal a ctio n s do n o t — g en era ted im m ed iate
criticism , m o st o f it eco n o m etric in n atu re, th e a u th o rs n o te. Using th e sam e data
set as A n d ersen an d Jo rd a n did, B atten an d T h o rn to n investigate th e validity o f
th e m a jo r criticism s o f th e St. Louis eq u atio n . In particu lar, th ey te st for b ia s due
to m issp ecificatio n , th e p re se n c e o f en d o g en o u s variables on th e rig h t-h an d side
o f th e eq u atio n , an d th e o m issio n o f ce rta in righ t-h an d -sid e variables. M oreover,
th ey rep o rt find ings p u b lish ed elsew h ere abou t th e d yn am ic sp e cifica tio n o f th e
St. Louis eq u atio n an d th e im p o sitio n o f p olyn om ial re strictio n s. In n o in sta n ce
co u ld th e a u th o rs find statistical su p p o rt for th e alleged, b u t previously u n tested ,
im p ro p rieties involving th e estim a tio n o f th e St. Louis eq u atio n .
In th e th ird article, K eith M. C arlson reviews th e d ev elop m en t o f th e m o n eta rist
e co n o m e tric m od el th at h e an d Andy p u b lish ed in th e April 1970 Review article
(reprinted b eg in n in g on p. 45) an d p re sen ts an u p d a ted version, co m p arin g it
w ith th e original m od el. T h e gen eral form o f th e m od el, th e a u th o r rep o rts,
rem ains u n ch an g e d ; it h a s b e e n sim plified to a rate-o f-ch an g e form , how ever, an d
som e su p p ly -sid e variables have b ee n add ed .
C arlson ex am in es th e p ro p erties o f th e u p d a ted m od el an d su m m arizes its
sim u lation p erfo rm an ce. T h e p ro p erties o f th e m o d el are little ch a n g ed from th e
original A nd ersen -C ariso n a rticle: m o n etary a ctio n s have su b sta n tia l sh o rt-ru n
effects o n total spen din g, o u tp u t an d u n em p loy m en t, b u t over th e lo n g run, the
effect o n total sp en d in g is reflected alm ost en tirely in th e p rice level. A lthough th e
m o d el's sim u lation p erfo rm an ce a p p ears satisfactory, a m o re a cc u ra te evaluation
aw aits co m p ariso n w ith sim ilar re su lts from o th e r m od els.

4




FEDERAL RESERVE BANK OF ST. LOUIS

OCTOBER 1986

The A ndersen-Jordan A pproach
after Nearly 30 Years
Jerry L. Jordan

T

J L O m y know ledge, th e label "m o n etarist' and its
essen tial p ro p o sitio n s w ere first p u t forth in an article
in th e Ju ly 1968 Review o f th e F ed eral Reserve Bank o f
St. Louis en titled “T h e Role o f M oney in M onetary
Policy” by Karl B ru nn er. In it, B ru n n e r states that,
T h e critiq u e o f e sta b lish e d p o lic y p ro c e d u re s, w h ic h
evolved from th is re s e a rc h in to q u e s tio n s c o n c e rn in g
th e m o n e ta iy m e c h a n is m , is d erived from a b o d y o f
m o n eta ry th e o ry refe rre d to . . . a s th e M onetarist p osi­
tion [e m p h asis ad d ed ]. T h re e m a jo r c o n c lu s io n s have
em erg ed from th e h y p o th e se s p u t fo rth . First, m o n e ­
tary im p u lse s are a m a jo r fa c to r a c c o u n tin g fo r v aria­
tio n s in o u tp u t, e m p lo y m e n t a n d p ric e s . S e co n d ,
m o v em en ts in th e m o n e y s to c k are th e m o st reliab le
m e a su re o f th e th ru st o f m o n e ta ry im p u lse s. T h ird , th e
beh av ior o f th e m o n eta ry a u th o rity d o m in a te s m ove­
m e n ts o f th e m o n ey sto ck over b u s in e ss cy c le s.

T h e p ro c e ss o f defining an d refining w hat w e now
m ean by m onetarism grew out o f a con troversy that
em erged in th e 1960s regarding th e relative im p o r­
ta n ce o f m on etary an d fiscal im p u lses. T h e d om in an t
eco n o m ic policy fram ew ork o f th e day w as an o u t­
grow th o f th e thin king o f th e 1930s, w h ich b eca m e
know n as K eynesianism . T h e rapid grow th o f govern­
m ent sp end in g asso ciated w ith th e V ietnam War, th e
Great Society program s an d relatively large d eficits in
th e federal govern m en t’s bu d g et w ere a sso ciate d w ith
co n d itio n s o f rapid e c o n o m ic grow th, rising inflation
an d a low u n em p loy m en t rate. T h e p o litical p re scrip ­
tion for th e problem o f inflation w as a su rtax on
person al an d co rp o rate in co m es to restrain aggregate
d em an d an d re d u ce inflation.

Jerry L Jordan is a senior vice president and chief economist at First
Interstate Bancorp, Los Angeles, California, and a former director of
research at the Federal Reserve Bank of St. Louis.



A d herents to th e p ro p o sitio n s th at b eca m e know n
as m o n etarism q u estio n ed w h eth er su c h fiscal a ctio n s
w ould, in fact, restrain aggregate d em a n d an d red u ce
inflation if m o n etaiy grow th rem ain ed as rapid as it
h ad b e e n previously. S in ce th e d o m in an t p o sitio n o f
th e tim e w as know n as th e K eyn esian revolution, th e
critics o f th at view w ere said to have m o u n ted a
m o n etarist co u n terrev olu tion . At tim es, th e quality of
th e d iscu ssio n w as silly, in clu d in g su ch in sigh ts as
“you can pull on a string, bu t y ou c a n ’t p u sh on a
strin g” an d “y ou ca n lead a h o rse to w ater, b u t y ou
c a n ’t m ake him d rink.” At o th e r an d m ore u seful tim es,
state-of-th e-art eco n o m etric te ch n iq u e s w ere u sed to
test rival c o n je c tu re s ab o u t m o n etary an d fiscal
im pulses.
T h e s k ir m is h e s o f th e p e rio d in c lu d e d th e
F riedm an-H eller d ebate, th e “B attle o f th e Radio Sta­
tio n s” — w h ich referred to th e re sea rch d o n e by
A ndo-M odigliani (AM) an d F ried m an -M eiselm an (FM)
— an d th e a sso cia te d co n trib u tio n s by D ePrano,
H ester an d M ayer an d by B ru n n e r an d M eltzer. T h e
role o f w hat b eca m e know n as th e gadfly o r m averick
resea rch d ep artm en t o f th e Fed eral Reserve Bank o f St.
Louis is n ow w ell-know n in ec o n o m ics circle s; al­
th ou gh it h ad started a few y ea rs earlier, it w as given
greatly h eig h ten ed visibility w ith th e p u b lica tio n o f
th e A n d ersen -Jo rd an (AJ) a rticle in 1968.
T h e 1966 cred it cru n c h an d su b seq u en t “m inire c e s s io n ” h ad d em o n stra ted th e p o ten tial for a re ­
strictive m o n eta iy policy, m easu red in term s o f a d e ­
ce le ra tio n o f m o n e ta iy grow th, to d o m in a te an
expansive fiscal im p u lse. In 1968, th e issu e w as
w h eth er m o n etary stim u lu s — as in d ica ted by c o n tin ­
u ed rapid grow th o f m o n ey — co u ld d o m in ate a
restrictive fiscal im p u lse as m easu red by a tax in ­
crease, re d u ctio n in th e high em p lo y m en t d eficit or

5

FEDERAL RESERVE BANK OF ST. LOUIS

som e o th e r su m m ary variable. T h e re se a rc h u n d erly ­
ing th e AJ article w as m otivated by tw o events: th e
Jo h n so n a d m in istratio n ’s an ti-in flatio n su rch arg e on
p erso n al an d co rp o rate in c o m e tax an d th e FOM C’s
d ecisio n to ease m o n etary p o licy to cu sh io n th e p re­
su m ed highly restrictive effects o f th e tax su rch arg e.
W e co n sid ere d th e AJ a rticle to b e a seq u el to th e FM
article. O ur p u rp o se w as to rigorously form u late p o ­
ten tially falsifiable h y p o th eses abo u t various m a c ro e c­
o n o m ic p o licy a ctio n s. T h e article also w as an ex ercise
in applying w h at w as th e n state-o f-th e-art co m p u te r­
ized regressio n p rogram s u sin g th e A lm on d istribu ted
lag for testin g h y p o th eses.
I believe that th e v eh e m en ce o f th e attack s o n th e AJ
a rticle aro se from tw o so u rces. First, th e resu lts o f th e
study sharply co n tra d icted th e in h erited w isd om of
th e tim es and raised serio u s d o u bts about o u r ability
to u se activist/discretionary fiscal p o licy to in flu en ce
th e eco n o m y in p red ictab le w ays.
A se c o n d re a so n fo r th e attack s w as sim ply th at th e
red u ced -fo rm ap p ro ach u sed in th e AJ study re p re­
sen ted a th reat to ec o n o m e tric m od el bu ild ers; it
provided a lo w -co st alternative to th e expensive efforts
at th e tim e to bu ild large-scale stru ctu ral m o d els of
th e U.S. eco n o m y . F o r exam p le, aro u n d th at tim e, th e
F ed eral R eserve B oard h ad e n tere d in to a co n tra ct to
sp en d ab o u t $1 m illion to bu ild w hat b eca m e know n
as th e FRB-M IT e c o n o m e tric m o d el. In m y ju d g m en t,
th e stru ctu ral m o d el-b u ild ers o f th e tim es sim ply
co u ld n o t afford to leave u n ch allen g ed th e c o m p e ti­
tio n th a t th is relatively ch e ap ap p ro ach p re sen ted in
evaluating p o licy effects on th e eco n om y. In an y event,
th o se th rea te n ed by its ch allen g e b o th to e co n o m ic
orth od oxy an d to th e u sefu ln ess o f large-scale m od els
h a d great in cen tiv e to seek to d iscred it th e AJ m e th o d ­
ology.
T hu s, as th e d ecad e o f th e 1960s en d ed , th e lin es
h ad b e e n draw n for a p rolon g ed in telle ctu al battle.
T h e K eynesian revolution w as still d om in an t, b u t th e
ch allen g e o f th e m o n etarist co u n terrev o lu tio n h ad
b ee n initiated . T h e 1970s w as a d ecad e o f form ulation,
reform u lation an d em p irical testin g o f th e alternative
views o f th e m ajo r m a cro e co n o m ic in flu en ces on the
eco n om y. By th e en d o f th e 1970s and in to th e early
1980s, fu rth er testin g o f m o n etarist p ro p o sitio n s by
a ctu al im p lem en tatio n w as attem p ted , at least in
nam e, if n o t in fact.
R ecently, th ere have b een n u m ero u s claim s that
m o n etarism h as failed. C ertainly th e ca se against
m o n etarism h as b ee n tried in th e p ress w ith jo u rn a l­
ists actin g as b o th p ro se cu to rs and jury. E co n o m ists,

6




OCTOBER 1986

how ever, have y et to co m p lete th e ir d elib eratio n s.
B eca u se th e “breakd o w n ” o f th e AJ re su lts is often
cited as evid ence against m o n etarism , I w ou ld like to
co m m en t briefly on th e cu rre n t controversy.

ON T H E RECEN T FA ILU R E’ O F
MONETARISM: IS
ANDERSEN-JORDAN’ P A S S E ?
T h e failure o f m o n eta rism h a s b e e n a sse rte d an d
reasserted often d uring th e p a st few y ears. T h is failure
is b ased on th e co n ten tio n th at th e relatio n sh ip b e ­
tw een m o n ey grow th an d GNP, o r m o n ey grow th an d
inflation, h as bro k en dow n. In p articu lar, th e beh avior
of th e in co m e velocity o f m o n ey over th e last few y ears,
esp ecially in 1985, h as raised q u estio n s a b o u t o n e of
th e cen tral p ro p o sition s o f th e qu an tity th eo ry of
m oney, o r m o n etarism — nam ely, th e stability o f the
dem an d fu n ctio n for m on ey. T h e sh arp d e c re a se s and
in crea ses in co n v en tion ally m e a su red velocity have
led to a ssertio n s th at th e d em a n d for m o n ey is u n s ta ­
ble and, th erefore, th e m o n ey su p p ly (M l) is n o lo n g er
a reliable in d ica to r o f th e th ru st o f m o n etary policy
im pulses.
Growth rates o f M l over sh o rt intervals d urin g th e
last few y ears have b een highly volatile, an d th e c o n ­
tem p o ran eo u sly m e a su red ratio o f GNP/M1 also h as
flu ctu ated over a w id e range. U nfortunately, b o th
m o n etarists an d th e ir critics seem to a c c e p t th e view
th at th e p u b lic p o licy relev an ce o f m o n eta rism d e ­
p en d s on th e sh o rt-ru n stability o f th e fu n ctio n al
relatio n sh ip b etw een d o m estic in c o m e and/or ou tp u t
an d grow th o f th e m o n ey supply. T h e sh o rt-ru n vola­
tility o f a d ata series su ch as th e ratio GNP/M1, h ow ­
ever, d oes n o t y ield an y definitive in fo rm atio n about
th e stability o f th e u nd erlying functioned relatio n sh ip
b etw een m o n ey an d ec o n o m ic activity.
T h ere are th ree im p o rtan t a sp e cts o f v elocity beh av­
io r in th e re ce n t p ast th at m u st b e exam in ed : th e role
o f in stitu tio n al ch an g es, th e im p lica tio n s o f lags and
th e ap p ro p riaten ess o f th e n u m era to r in co m p u tin g
th e velocity ratio.

Institutional Changes
Som e an alysts a ssert th a t d eregu latio n o f th e fin an ­
cial system , starting w ith th e D epository In stitu tio n s
D eregulation an d M on etary C ontrol Act o f 1980 and
co n tin u ed w ith th e G arn-St. G erm ain legislation in
1982, h as a ltered th e beh av io r o f M l and , in tu rn, h as
ca u sed th e volatile beh avior o f v elocity in th e last two
y ears. T h e em p irical issu e, o n w h ic h th e re is n o c o n ­

FEDERAL RESERVE BANK OF ST. LOUIS

sen su s at th is tim e, is th e degree to w h ich th e "d e ­
m an d for m o n ey b a la n c e s ” has shifted upw ard rela­
tive to in c o m e o r w ea lth and , c o n se q u e n tly , a
d ow nw ard shift in at least th e level, an d po ssibly th e
tren d grow th rate, o f M l velocity.
It h as b ee n argued th at th e rem oval o f R egulation Q
in tere st ceilin g s on ban k d ep o sits an d th e innovation
of n ew types o f d ep osit in stru m en ts has resu lted in
M l co n tain in g a large savings co m p o n e n t. Therefore,
faster grow th o f th e m o n ey supply, su ch as w hat
o cc u rre d in 1985-86, sh o u ld not be taken as an in d ica ­
to r o f as m u ch stim u lu s as befo re sin c e th e d em an d
for m o n ey b a la n ces is also rising. W ith out an e x cess
su p p ly co n d itio n , it is argued, th e re is no re a so n to
ex p e ct n om inal in co m e grow th to accelera te.
M o n etarists generally a c c e p t th e view th at d eregu la­
tio n an d fin an cial inn ovation have m o st likely resu lted
in a red u ctio n in th e tren d rate o f grow th o f M l
velocity. T h ere is no reason , how ever, to believe th at
th e level o f velocity w ou ld b e ex p e cted to d eclin e. T h e
tren d rate o f in cre a se o f h isto ric M2 velocity h as b ee n
betw een 0 an d 1 p e rce n t. M2 h as alw ays co n tain e d a
relatively large savings co m p o n e n t. D eregu lation an d
innovation m ay have resu lted in M l taking on the
ch a ra cte ristics o f h isto ric M2. At th is p oin t, how ever,
w e do n o t have su fficient evid ence to draw firm
co n clu sio n s.
Even if M l is n ow like old M2, th e tren d rate o f
in crea se o f M l velocity w ould have d eclin ed from th e 3
p e rce n t rate o f th e p o st-w ar period to so m eth in g m ore
sim ilar to h isto ric M2 velocity grow th. T h e re is no
th e o retical reaso n an d no evid ence to suggest that th e
tren d o f M l velocity w ould be negative as a resu lt o f
d eregu lation and innovation.

The Role o f Lags
T h e e x iste n ce o f lags in an en viro n m en t o f highly
volatile sh o rt-ru n m o n ey grow th m ust p ro d u ce a
highly volatile d ata series for velocity. Volatility o f the
d ata series, how ever, d o es n o t y ield u seful in form ation
abou t th e stability o f th e u nd erlyin g fu n ctio n al re la ­
tion sh ip .
T h is p o in t ca n be illu strated w ith a sim ple exam ple.
Su p p o se it w ere know n w ith certain ty th at th e lag
b etw een ch an g es in m oney and ch an g es in n om in al
in co m e w as exactly 180 days. Su p p o se fu rth er th at th e
grow th o f M l a cc e le ra te d an d d ecelera ted sharp ly
over intervals lasting exactly six m o n th s. Starting from
any initial con d itio n , a sharp accelera tio n in M l
grow th for six m o n th s w ould n o t be m a tch ed by an
a ccelera tio n in th e grow th o f th e n u m era to r o f th e



OCTOBER 1986

v elo city ra tio . C o n se q u e n tly , c o n te m p o ra n e o u s ly
m easu red velocity (V) w ou ld d eclin e d urin g th e
interval.
At th e en d o f six m o n th s, th e n u m era to r w ould
begin to rise m ore rapidly, w hile th e d en o m in a to r
d ecelerated , ca u sin g a sh arp in cre a s e in th e V-ratio.
Six m o n th s later, o n c e again th e d en o m in a to r w ould
a ccelera te w hile th e n u m era to r d ecelera ted , ca u sin g a
plu n ge in th e V-ratio. O bserving th e b eh av io r o f th e Vratio over several s u c h cy cles co u ld easily lead an
u nd ergrad u ate m on ey -an d -b an kin g stu d en t to c o n ­
clu d e th at velocity, o r th e d em an d for m oney, w as not
stab le. It w as a p erfectly stab le a n d p re d icta b le fu n c­
tion al relatio n sh ip , how ever, that p ro d u ced th e vola­
tility o f th e d ata series.
T h e relevance o f th e p o in t is that, over th e last
several y ears, w e have observed in creasin g ly sharp
a ccelera tio n s an d d ecelera tio n s o f M l grow th, w ith
e a ch m ovem ent in th e rate o f ch a n g e ten d in g to last
tw o to th ree qu arters follow ed b y a sh arp reversal.
Sin ce th e real-w orld lag is n o t d iscrete, bu t ra th er is
d istribu ted and variable, th e ch a llen g e to em p irical
re sea rch is to develop te ch n iq u e s to id entify th e a ctu al
lag stru ctu re.

Appropriate Numerator
It is co m m o n p ra ctice to co m p u te th e velocity of
m o n ey as th e ratio o f GNP divided by M l o r a b ro ad er
m o n ey m easu re. T h e original qu an tity th eo ry eq u a ­
tion, how ever, w as MV = PT, w h ere T is tra n sa ctio n s.
C hanges in GNP reflect prim arily ch a n g es in d o m estic
output at prevailing p rices, n o t total tra n sa ctio n s at
prevailing p rices. T h e u se o f GNP in th e velocity ratio
im plies b o th a clo sed eco n o m y a n d th e stability o f
su ch co m p o n e n ts as b u sin ess in ven tories. S in ce th o se
assu m p tio n s are not a good rep resen ta tio n o f th e real
w orld, th e u se o f GNP for co m p u tin g velocity ca u ses
several p roblem s.
In casu al conversation, it is co m m o n to refer to GNP
as a m easu re o f aggregate d em a n d o r to tal sp en d in g in
th e eco n om y. It is n o t. A rigorous form u lation o f th e
qu an tity theory o f m oney, o r m o n etarism , involves a
sta tem en t abou t th e d em a n d fo r m o n ey b a la n c e s re la ­
tive to w ealth o r p e rm a n en t in co m e. Sin ce qu arterly
flu ctu atio n s in GNP as co m p iled by th e C om m erce
D epartm en t are not a good proxy for ch a n g es in
w ealth o r p erm a n en t in co m e, th e u se o f GNP to co m ­
pu te th e inverse o f th e d em an d for m o n ey — velocity
— ca u ses sign ifican t m e a su re m en t p roblem s.
T h e th eory im plies th at an a ccelera tio n in m o n etary
grow th resu lts in in crea sed sp en d in g grow th. In a

7

FEDERAL RESERVE BANK OF ST. LOUIS

clo sed eco n om y, a sh o rt-ru n m an ifestatio n o f th e in ­
crea se d sp en d in g w ould be an involuntary an d u n a n ­
ticip ated re d u ctio n in b u sin ess inventories, in crea sed
ord ering and in creased p ro d u ctio n . T h e longer-term
effect is a re d u ctio n in th e p u rch asin g p o w er o f n o m i­
nal m o n ey u n its — inflation.
In an o p en econom y, an in cre a se in m o n ey grow th
m ay b e acco m p a n ie d by an in cre a se in d em an d for
im p orted good s as w ell as d om estically p ro d u ced
output. A sh arp an d su stain ed a ccelera tio n o f m on ey
grow th th at is acco m p a n ie d by a large in crea se in
im p orts su ggests a d eclin e in th e GNP/M1 ratio, at
least for a w hile. O th er a d ju stm en ts, how ever, grad u ­
ally do take p la ce — su ch as in th e foreign ex ch an g e
value o f th e d o m estic cu rre n cy w h ich ch an g es th e
relative p rices o f in tern atio n ally trad ed o u tp u t; even­
tually m ore co stly im p orts and m ore com p etitive e x ­
p o rts will reverse th e situ ation. T h o se lags can be veiy
long an d are difficult to p red ict, in tro d u cin g fu rth er
u n certain ty into th e relation b etw een m o n ey an d GNP
grow th. T h is p h e n o m e n o n lim its th e u sefu ln ess o f
m o n etarism in co n d u ctin g sh o rt-ru n -o rien ted d iscre­
tionary p o licies sin c e th e u sefu ln ess o f m on ey grow th
as a n in d icato r o f th e th ru st o f m o n etary p o licy is
usually gauged in term s o f its reliability in forecastin g
GNP grow th.

WHAT REMAINS O F TH E
ANDERSEN-JORDAN APPROACH?
O ne ce n tra l m o n etarist p ro p o sition h as alw ays b een
th at activist, d iscretio n ary p o licies are n e ith e r n e c e s ­
sary n o r d esirable. T h erefore, it is iro n ic that th e "St.
Louis eq u atio n ” u n in ten tio n ally stren g th en ed th e
view s o f th e p u b lic p o licym akers w h o w an ted to
“m a n ag e” m o n e ta iy policy to ach ieve d ifferent e c o ­
n o m ic resu lts. T h e em p irical relatio n b etw een m o n ey
grow th an d n o m in al in co m e w as u sed as a ratio n a liz a ­
tion for an activist, d iscretio n ary policy u n d e r w h ich
fa ste r o r slow er target grow th rates for m o n ey w ere
ad o p ted to achieve faster o r slow er grow th rates o f
n o m in al GNP and, in tu rn, m ore o r less inflation,
o u tp u t an d em p loym ent.

8




OCTOBER 1986

T h e u se o f th e St. Louis eq u atio n to engage in “finetu n in g ” w as n e ith e r in ten d e d n o r a n ticip a te d by us.
As I n o ted earlier, o u r in ten t w as to d em o n stra te th at
expansive m o n eta iy fin e-tun in g, in ten d ed to offset a
p resu m ed co n tra ctio n a ry fiscal im p act, w as n eith e r
n e c e s s a iy n o r d esirab le. M u ch to o u r su rp rise and
chagrin, o u r resu lts w ere u sed by so m e to d em o n ­
strate th e efficacy o f m o n etary fin e-tu n in g .
T h e b a sic p ro b lem w ith activist p o licies is th at n u ­
m erou s factors affect e c o n o m ic p e rfo rm a n ce; in th e
p a st two d eca d es, th e re have b e e n am p le o p p o rtu n i­
ties to a ccu m u la te d ata abou t th e effects o f b o th p o licy
an d n o n -p o licy d ev elo p m en ts on e c o n o m ic activity.
Yet, very little, if anything, h a s b e e n le a rn ed from all
th is a ccu m u la ted ex p e rie n ce . T h e lags in th e effects of
policy a ctio n s are ju s t as variable an d ju st as u n c e r­
tain, an d p o licy a ctio n s still a c c o u n t fo r le ss th a n h alf
th e variability o f ec o n o m ic variables.
T h e ap p en d ix to th e A n d ersen -Jo rd a n a rticle e m ­
p h a siz es th e im p o rta n ce o f th e “Z -factor,” a variable
su m m arizin g all th e o th e r fo rces th a t in flu en ce to tal
sp en d in g in th e eco n o m y . W hile th e tex t o f th e article
co n clu d e d th at m o n eta ry p o licy a ctio n s w ere re la ­
tively m o re im p o rtan t th an fiscal a ctio n s, th e analysis
in th e ap p en d ix su ggests th a t a m o re co m p lete c o n ­
clu sio n w ould have b e e n “an d n o n -p o licy fa cto rs are
even m o re im p o rta n t.” T h e a rtic le ’s im p a ct o n e c o ­
n o m ic policym aking w ou ld have b e e n m o re favorable
had it n o t led to an in c re a s e d re lia n ce on m o n etary
over fiscal policy, b u t h ad it in stea d co n trib u te d to a
gen eral d e-em p h asis o f fin e-tu n in g a ttem p ts b y p o li­
cym akers. Som e o f th e fru stratio n an d d isa p p o in t­
m ent ex p ressed by m o n eta iy p olicym akers in re cen t
y ea rs m ay have resu lted from th e u n satisfacto ry
resu lts th ey observed from th is m isu se o f th e theory.
In m y ju d g m en t, th e en d u rin g co n trib u tio n o f th e AJ
a p p ro ach is th e m eth od ology em p loy ed to a sse ss th e
d ifferential im p a cts o f p o licy a ctio n s o n th e eco n om y,
n ot th e sp ecific resu lts offered at th e tim e. W hile
in stitu tio n al an d tech n o lo g ica l ch a n g es over tim e m ay
alter em p irical results, stu d en ts o f p u b lic p o licy d e ­
b a te s c a n still u sefu lly ap p ly to d a y th e sin g le ­
eq u ation , red u ced -fo rm a p p ro a ch u sed by th e AJ
study 18 y ears ago.

FEDERAL RESERVE BANK OF ST. LOUIS

OCTOBER 1986

The M onetary-Fiscal Policy Debate
and the A ndersen-Jordan
Equation
Dallas S. Batten and Daniel L. Thornton

p

ERHAPS Andy's m o st im p o rtan t an d lastin g c o n ­
trib u tion to th e ec o n o m ics p ro fessio n w as h is re ­
sea rch w ith Jerry Jo rd a n th at resu lted in th e p u b lica ­
tio n o f th e A n d ersen -Jo rd an (A-J) eq u atio n or, as it is
m ore w idely know n, th e St. Louis eq u atio n . Alm ost
im m ed iately, th e tw o fou n d th eir w ork th e su b je ct o f
in ten se criticism an d controversy — m u ch o f w h ich
co n tin u es, thou gh in to n e s th at are significantly
m u ted .'
W hile th e criticism s o f A n d ersen -Jo rd an w ere fo­
cu sed on various te ch n ica l and ap p lied eco n o m etric
a sp e cts o f th e ir work, th ey w ere m otivated, in large
part, by A -J’s co n clu sio n th at m o n etary p o licy h as a
significant and lasting effect on n o m in al GNP and th at
fiscal p o licy h as n o lastin g effect. T h e se re su lts c o n ­
flicted sh arp ly n o t only w ith th e co n v en tion al w isd om
abou t th e relative effects o f m o n etary an d fiscal p o licy
a ctio n s bu t w ith th e resu lts o f large-scale eco n o m e tric
m od els o f th e tim e.
T h e p u rp o se o f th is p ap e r is to review th e criticism s
that em erged follow ing th e p u blicatio n o f th e A-J
equation.- W e n o te that m any, if n ot all, o f th e criti­
cism s o f th e A-J p ap e r apply equally w ell to th e vast
m ajority o f p u blish ed re search , th en and now . M ore
im portantly, u sin g th e original A-J data, w e find no
evid ence to su p p o rt th e se criticism s.

Dallas S. Batten and Daniel L. Thornton are research officers at the
Federal Reserve Bank of St. Louis. Rosemarie V. Mueller provided
research assistance.
'The monetary-fiscal policy debate was actually initiated prior to
Andersen-Jordan (1968) by Friedman and Meiselman (1963). Just
as the ensuing debate surrounding Friedman and Meiselman’s
results was waning, however, Andersen and Jordan appeared,
rekindling and intensifying the disagreement over the relative effi­
cacy of monetary and fiscal policies.
2While our review differs from recent ones by McCallum (1986) and
Meyer and Rasche (1980), it is necessary to traverse some of the
ground they covered.



TH E ST. LOUIS EQUATION AMD
ITS CRITICS
R ecently, C ooley an d LeRoy (1981) have argued th at
a clo se co rre sp o n d e n c e te n d s to exist b etw een th e
advocacy o f a th eo ry an d th e re su lts o f scien tific inves­
tigation. It is not surprising, th erefo re, th at w h en two
know n an d vocal p ro p o n en ts o f m o n etarism rep o rted
em p irical resu lts th at strongly su p p o rted m o n etarist
pro p o sition s, th e resu lts w ere received w ith sk ep ti­
cism , w h ich w as in ten sified by th e ir u se o f a single,
"re d u ce d -fo rm ” eq u atio n . C ritics w ere su sp icio u s that
A-J inadvertently h ad eith e r m issp ecified th e m od el or
used faulty e co n o m etric te ch n iq u e s to ob tain th eir
results/'
T h ree m a jo r criticism s em erg ed follow ing th e p u b li­
catio n o f th e A-J eq u atio n . First, it w as argued th at th e
eq u ation w as m issp ecified b ec a u se im p o rtan t exo g e­
nous, righ t-h an d -sid e variables had b een exclu d ed .
Secon d , critics claim ed th at A -J’s u se o f ord in ary least
sq u ares (OLS) h ad resu lted in sim u lta n eo u s eq u atio n
bias. Finally, it w as asse rte d th at A-J h ad failed to
identify th e relevant exo g en o u s in d ica to rs o f m o n etaiy an d fiscal policy a ctio n s. In ad d ition , critics w ere
co n cern e d th at th e A-J resu lts w ere sa m p le-sp ecific or
n ot robu st to various ec o n o m e tric m o d ification s, in ­
clu d in g th e ir u se o f A lm on’s (1965) poly n om ial d istrib ­
uted lag estim atio n tech n iq u e. T h e p erce p tio n th at A-J
had so m eh o w erred w as e n h a n c e d w h en d e Leeuw
and K a lch b ren n er (1969), Silb er (1971) an d Sch m id t
an d W aud (1973) tried u n su ccessfu lly to re p lica te th e

3A number of critiques appeared very shortly after the publication of
the A-J paper, e.g., de Leeuw and Kalchbrenner (1969), Davis
(1969), Corrigan (1970), and Goldfeld and Blinder (1972).

9

FEDERAL RESERVE BANK OF ST. LOUIS

A-J resu lts.4 T h e follow ing se c tio n s ex am in e th e se c rit­
icism s.

M ISSPECIFICATION
T h e ch arge th at A-J h ad m issp ecified th e ir eq u atio n
by om ittin g im p o rtan t variables, o th e r th a n m on etary
an d fiscal p o licy variables, w as leveled by n u m ero u s
co m m en tato rs. To u n d e rstan d th is argum ent, c o n ­
sid e r th e original A-J eq u atio n :
3
( 1 ) AY, = a +

2

i= 0

3
p, A M ,_, +

2

i= 0

-y, AE , , + u, ,

w h ere Y, M an d E d en o te n o m in al GNP, th e m on ey
stock (M l) and n o m in al h ig h -em p loy m ent govern­
m e n t exp en d itu res, respectively, an d u, d en o te s th e
u su al rand om d istu rb an ce term .3 T h is eq u atio n ca n be
w ritten m o re co m p actly as:
(2) AY, = a + (J (L )A M , +

7

ILIA K , + u, ,

w h ere (3(L) an d 7(L) are p olynom ials in th e lag o p era ­
to r L, su c h th a t L"x, = Lx,_„ an d w h ere p(L)Ax, are
d istribu ted lags o f a finite o rd er k.“ A-J c h o se k = 3.
If a relevant ex o g en o u s p o licy variable, Z„ is om itted ,
th e tru e sp ecificatio n is n ot eq u atio n 2, but
131 AY, = a + p iL lA M , +

7

(L )A E , + 5 (L )A Z , + e, ,

in w h ich c a s e th e erro r term in eq u atio n 2 is u, =
8(L)AZ, + £,. Fu rth erm o re, estim ates o f th e m o n etary
a n d fiscal p o licy re sp o n ses from eq u atio n 2 w ill be
b ia sed if AZ, is co rrela ted w ith AM, o r AE,.
T h is criticism o f th e A-J eq u atio n , w hile poten tially
d am aging if valid, ap p lies equally w ell to virtually all

4lt now appears that these differences resulted from differences in
programming or in the imposition of polynomial restrictions. Batten
and Thornton (1985) have replicated the A-J results to the second or
third decimal place. Even though other researchers may have been
unable to replicate the A-J results exactly, their studies generally
supported the qualitative findings of A-J.
5The original A-J paper also contained specifications with the ad­
justed monetary base as the indicator of monetary policy actions
and a distributed lag of high-employment government revenues as
an additional right-hand-side variable. Equation 1 is the most com­
monly estimated form of the equation, however.
Furthermore, following an exchange between Friedman (1977)
and Carlson (1978), the equation was specified in growth rates of
the variables. It is interesting to note that A-J also estimated a
growth-rate specification, but only reported the first-difference
results. For the most part, the issues discussed below are indepen­
dent of the specification.
6The notation used here is the same as employed by McCallum
(1986).
Digitized for10
FRASER


OCTOBER 1986

applied e co n o m etric re sea rch , in clu d in g m o st largescale, sim u lta n eo u s-eq u a tio n e c o n o m e tric m o d els o f
the A-J vintage.7 M oreover, alth o u g h it w as co m m o n ly
argued th at th e A-J eq u a tio n w as poten tially m issp e c i­
fied, e co n o m etric th eo ry d o es n o t su ggest th a t it is
m ore su sce p tib le to th e resu ltin g b ias th a n o th e r esti­
m ated eq u atio n s. In d eed , th e re w as n o ev id en ce th at
th e ir resu lts w ere b iased sin c e n o te sts for m issp ecifica tio n w ere p erform ed .
W hile th e ir resu lts provided n o ev id en ce th a t th e A-J
eq u atio n is m issp ecified , M odigliani an d A ndo (1976)
p re sen ted evid en ce from a M o n te C arlo-style ex p eri­
m en t th at led som e to d o u b t th e validity o f th e A-J
re su lts * Using artificial d ata g en era ted by th e MPS
eco n o m etric m odel, th ey u sed a St. L ouis-style eq u a ­
tio n to estim ate th e red u ced -fo rm p a ra m eters. T h e
resu lts in d ica ted th at th e St. L ouis-style eq u atio n p ro ­
d u ced p o o r estim a tes o f th e “tru e ” m o n eta ry and
fiscal m u ltipliers, serio u sly overstating th e size o f th e
m o n etary in flu en ce an d u n d erestim a tin g th e m agn i­
tu d e o f th e fiscal policy effect. T h ey co n c lu d e d that
th e A-J red u ced -fo rm estim a tio n te ch n iq u e y ield ed
u nreliab le estim ates.
T h is co n clu sio n , how ever, is u nw arranted .'1 If a

7For example, Duesenberry et al. (1965).
8See McCallum (1986), p. 17 and footnote 16.
9McCallum (1986) criticized the Modigliani-Ando results by arguing
that they failed to distinguish between reduced-form and “finalform” multipliers. He considers the case where AZ, = a0 + a, AY,_,
+ a2AM,_, + a3AE,_, + e,. Substituting this expression into equa­
tion 3 yields the following: AY, = a + 0'(L)AM, + -y'(L)AE, + E;
where the coefficients are defined to conform, e.g., 0'(L) =
[1 -La,8(L)]“ 1[0(L) + La;,5(L)]. In contrast to the finite order distrib­
uted lags of the A-J equation 2, the distributed lags on this final-form
equation are of an infinite order. Also, the error term of the A-J
equation, u„ is hypothesized to be white noise, while that of the
above equation, e is an infinite order AR process under the as­
sumption about u,. The distinction between reduced- and final-form
equations may not be important, however, because if the lags of the
final-form equation are truncated to match those of equation 2,
these equations are indistinguishable save the error structure. While
this difference will allow one to distinguish between the two equa­
tions, it will only do so if one is willing to make strong claims about
the underlying distribution of u,. (McCallum notes this; see p. 24,
footnote 8).
It is interesting to note, however, that our results obtained by
adding a distributed lag of AY to the A-J equation support McCallum’s idea that the A-J results reflect ail of the direct and indirect
effects via lagged values of nominal GNP. A-J and Darby (1976)
argued that the equation captured direct and indirect effects via
other contemporaneous endogenous variables.
McCallum also argues correctly that “it is hard to imagine any
important macroeconomic variable that is truly exogenous . . (p.
13). If there are really no exogenous variables, however, then the
true reduced form would be a Sims-type VAR model where the only
exogenous variables would be the policy and, perhaps, other
innovations.

FEDERAL RESERVE BANK OF ST. LOUIS

stru ctu ral m odel is well defined w ith additive, n o r­
m ally d istribu ted errors, co n siste n t estim ates o f the
red u ced -fo rm p aram eters can be o btain ed by th e u se
o f in d irect least squ ares, a la A -J.l(l B e ca u se th e MPS
m od el d oes n ot n ecessarily reflect th e tru e stru ctu re
o f th e U.S. eco n o m y (for exam ple, it ignores poten tially
im p o rtan t so u rces o f crow ding out throu gh w ealth
effects an d R icardian equivalence), th e M odiglianiAndo exp erim en t can n o t b e a criticism o f th e A-J
resu lts o r o f th e A-J m eth o d olo gy ." C on sequen tly, th e
M odigliani-A ndo evid ence is p red om in an tly a sta te ­
m ent about K eynesian vs. m o n etarist views o f the
w o rld .1 Fu rth erm ore, they provide no general infor­
m atio n co n cern in g th e u sefu ln ess o f th e red u ced form estim atio n . By design, th e A-J eq u atio n did not
co n fo rm to th e re d u ce d form o f th e MPS m od el; so it is
n o t su rp risin g th at th e p aram e te r estim ates w ere
poor. T h e exp erim en t m erely rem in d s u s that, if o n e
estim ates a red u ced form th at is know n to be m issp ecified, th e resu lts m ay be biased .

Gordon’s Evidence
E xcep t for th e u sual ch e ck s for serial co rrelatio n
an d h etero sk ed asticity , th e A-J eq u atio n w as n o t su b ­
je c te d to form al te sts o f m od el sp ecificatio n . G ordon
(1976) cam e clo sest to testin g th e A-J eq u atio n for m issp ecificatio n . He ad ded a set o f “o m itted variables,” Z,
to th e St. Louis eq u ation. C laim ing that th e se variables
w ere n o n sto ch a stic, h e te ste d for th e ir statistical sig­
n ifica n ce and m easu red th e im p act o f th e se variables
on th e A-J eq u atio n sim ply by observing w h eth er th ey
affected th e size and statistical sig n ifican ce o f th e
estim ated long-run m o n eta iy and fiscal m u ltipliers.
Unfortunately, the Z-variable h e co n stru c te d — the
sum o f n et exports, co n su m e r ex p en d itu res on new
au to m o biles and n o n resid en tial fixed investm ent —
w as arguably m o re en d o g en o u s th a n th e m o n ey an d

'“Unique estimates of the structural parameters cannot be obtained,
however, unless the system is exactly identified.
"Klein (1976), p. 50, noted in his discussion of the Modigliani-Ando
paper, “If the world were constructed along lines portrayed by the
MPS model, St. Louis conclusions could have been innocently
obtained by one who did not bother to estimate the structure. This is
the strongest statement that can be made.”
12Gordon (1976) chides Schwartz (1976) for missing the point of the
Modigliani-Ando critique because she criticizes the specification of
the MPS model. But this is exactly the point. Gordon later states
incorrectly that “the major contribution of the paper is its demonstra­
tion that the correlation between included policy variables and other
excluded variables severely biases the estimated St. Louis multipli­
ers and renders useless the reduced form technique” (p. 60).



OCTOBER 1986

ex p en d itu re variables th at A-J h ad u sed . H ence, Gor­
d o n ’s results, w hile by an d large favorable to A-J, say
little abou t w h eth er A -J's resu lts w ere affected by
sp ecificatio n erro r.1
3

R E S E T T e st R e su lts
Ideally, o n e sh o u ld test th e sp e cifica tio n o f a m odel
by co m p arin g it w ith a w ell-sp ecified alternative. Sin ce
the red u ced form o f th e MPS m o d el (or an y o th e r
large-scale K eyn esian m odel) is w ell sp ecified , it
cou ld , in prin cip le, be u sed as th e alternative in a test
o f the A-J eq u atio n . U nfortunately, m o st large-scale
m od els have to o m any ex o g en o u s variables for th e
red u ced form to b e estim a ted d irectly. Even if it cou ld
b e estim ated directly, how ever, it w ou ld b e difficult to
o btain a data set th at is co m p arab ly d ated w ith the
original A-J data.
T h is h a s p ro m p ted u s to u se a g en eral te st o f m issp ecification , th e RESET test o f R am sey an d Sch m id t
(1976), w h ich requ ires n o ad d ition al data. T h e RESET
test is a gen eral d iag n o stic test for various types o f m issp ecificatio n s, in clu d in g om itted variables, w h ere the
alternative h y p oth esis is n o t w ell sp e cified .1 A pplied
4
to eq u ation 2, th e F -sta tistic ca lcu la ted a cco rd in g to
th e R am sey-Sch m id t version o f th e R ESET test is .52,
w h ich is n o t sign ifican t at th e 5 p e rce n t level.1 H ence,
3
the RESET test provides n o su p p o rt for claim s th at the
original A-J eq u ation w as m issp ecified b ec a u se A-J
h ad om itted sign ifican t ex o g en o u s variables from
th e ir analysis.

13Gordon performed no formal tests. He noted merely that, when his
Z-variable was included, the sum of coefficients on AM became
smaller and, during one short period, was insignificant. (This period
is the one for which the correlation between AM, and AM,_, and his
composite variable is the highest.) There was no discussion, how­
ever, of the problem of multicollinearity or possible bias induced by
including variables that are clearly endogenous. (If these extrane­
ous variables do not belong in the model, the estimates are consist­
ent but may be biased in small samples.)
,4ln general, if an equation is misspecified, the residuals will have a
non-zero mean. The RESET test is designed to detect a non-zero
mean of the residuals. The test is performed by adding AY2, AY3, ...,
AYhas additional regressors to equation 2 and testing the hypothe­
ses that these regressors have no joint effect on the dependent
variable. The test here was performed for h = 2, 3, 4; the result with
the lowest significance level (in this case, h = 3) is reported. See
Fomby, Hill and Johnson (1984), pp. 411-12, for a discussion of the
RESET test.
15When A-J originally estimated equation 2, they used restricted least
squares in the form of Almon’s (1965) polynomial distributed lag
estimation technique. We have recently shown, however, that none
of the important conclusions of A-J depend on these restrictions
[Batten and Thornton (1985)]. Consequently, all of the empirical
results reported here are obtained with OLS.

11

FEDERAL RESERVE BANK OF ST. LOUIS

OCTOBER 1986

SIMULTANEOUS EQUATION BIAS
A n u m b er o f critics argued th at th e A-J resu lts w ere
u n reliab le b e c a u se th e ir p o licy variables w ere not
strictly exo g en o u s. B e ca u se o f th e ir know led ge o f th e
issu es su rro u n d in g targets and in d icato rs o f m o n eta iy
policy, A -J w ere acu tely aw are o f th e n ee d to select
ex o g en o u s in d icato rs o f policy. In d eed , they c o n sid ­
ered a b ro ad ran ge o f m e asu res o f m o n eta iy a n d fiscal
a ctio n s th at had b ee n cite d frequ en tly in th e litera ­
ture."* In th e ir analysis, th ey a ssu m ed th at all ex clu d ed
variables eith e r w ere in d e p en d e n t o f m o n eta iy an d
fiscal a ctio n s o r w ere in flu en ced by th em , so th at
m o n e ta iy an d fiscal p o licies ex erted an in d irect effect
o n th e eco n o m y th rou gh th e se fa cto rs.'7 A-J reaso n ed
th at if m o n eta iy an d fiscal in flu en ces w ere n o t in d e­
p e n d e n t o f o th e r factors, th e c o n sta n t term , w h ich
th ey argued su m m arized th e im p act o f th e se factors,
w ou ld have ch an g ed as th e se variables ch an g ed . Using
a C how test to test w h eth er th e p aram eters o f th e ir
eq u atio n w ere tem p orally stable, th ey fou nd n o evi­
d e n c e o f instability.

Given th e a tten tio n th at A-J gave to th is issu e, it is
odd th a t th e ir w ork w as singled ou t as s u b je c t to
sim u ltan eo u s eq u atio n bias, w h en a n u m b er o f w orks
o f a p p lied e c o n o m ics o f th is vintage w ere n o t criti­
ciz ed for applying OLS to eq u atio n s w ith righ t-h an d sid e variables th a t w ere m o re clearly en d o g en o u s."1

Wu Test Results
Again, d esp ite claim s th at th e A-J resu lts w ere q u e s­
tio n able on g ro u n d s o f sim u ltaneity, sy stem atic te s t­
ing for sim u ltan eo u s eq u atio n bias h as b ee n sparse.
M cC allum (1986) co m p ared OLS an d in stru m en tal
variables (IV) estim ates o f th e A-J eq u atio n , bu t p e r­
form ed n o form al te sts. E xten d in g M cC allu m ’s an aly­
sis, w e perform a W u (1973) test u sin g th e original A-J
data. Like M cC allum , w e u sed th ree lags o f AM, AE
an d th e th ree-m o n th T re a su iy bill rate as in stru m en ts
for AM, an d AE,. T h e resu lts are rep o rted in table 1.

16Both Andersen and Jordan participated in a Conference on Indica­
tors and Targets of Monetary Policy held at UCLA in 1966. Andersen
contributed to the conference proceedings; see Andersen (1969).
17This possibility was also considered by McCallum (1986) and Darby
(1976), though McCallum included a lagged dependent variable to
obtain his distinction between the reduced form and the final form;
see footnote 9 above.
,80ne of the most important of these was Chow’s (1966) pathbreaking
work on money demand, in which current values of real GNP and a
nominal interest rate appeared on the right-hand side of the
equation.
12



Table 1
OLS and IV Estimates of the
Andersen-Jordan Equation
Variable
OLS
Constant
2.311*
(2.82)
AM,
2.121*
(2.87)
AM, ,
0.312
(0.32)
am ,_2
2.696*
(2.69)
AM, 3
0.671
(0.87)
SAM,
5.800*
(7.34)
0.379
AE,
(1.40)
AE,_,
0.523
(188)
ae ,_2
0.022
(0.08)
-0.763*
AE,_3
(2.95)
2AE,
0.161
(0.52)
Joint F-test, AM
15.84*
3.17*
Joint F-test, AE
R2
0.61
DW
1.747
SE
3.96

IV
2.548*
(2.45)
0.676
(0.33)
1.652
(0.84)
2.005
(1.56)
0.452
(0.51)
4.785*
(3.68)
1.300
(1.46)
0.315
(0.81)
-0.217
(0.54)
-0.832*
(2.81)
0.566
(1.17)
8.65*
2.75*
0.54
2.010
4.42

'Indicates statistical significance at the 5 percent level.
Absolute value of t-ratio in parentheses

A co m p a riso n o f OLS an d IV estim a tes sh ow s som e
large d ifferences, p articu larly for th e co efficien ts on
AM, an d AE,. T h e IV estim a tes sh o w a sm a lle r initial
effect o f m o n ey an d a larger initial effect o f govern­
m ent ex p en d itu res relative to th e OLS estim a tes. Nev­
erth eless, th e Wu test ch i-sq u a re sta tistic is .20, not
statistically sign ifican t at th e 5 p e rce n t level.

It is n ot too su rp risin g th at th e IV estim a tes are
relatively im p recise. T h e first-stage R-s w ere .54 an d .38
for AM, an d AE,, respectively. M oreover, th e fact th at
th ree lags o f AM, an d AE, are u sed as in stru m en ts
m ean s th at AM, an d AE, are likely to b e highly c o rre ­
lated w ith th e o th e r reg resso rs o f th e A-J eq u atio n .
W hile the test co u ld b e ca rried out w ith alternative
in stru m en ts, th ere is n o obvious g uide to th e ir s e le c ­
tion. In any event, it is unlikely th at th e resu lts will be

FEDERAL RESERVE BANK OF ST. LOUIS

Table 2
Estimates of an Autoregressive Version
of the Andersen-Jordan Equation
Coefficient
Variable
t-ratio’
Constant
2.464*
(2.58)
2.049*
AM,
(2.84)
AM,.,
-0.206
(0.21)
2.971*
am ,_2
(2.98)
AM, _3
0.399
(0.45)
2AM,
5.213*
(5.11)
0.277
AE,
(0.97)
AE,_,
0.638*
(2.27)
AE, 2
0.025
(0.09)
AE, 3
-0.709*
(2.80)
SAE,
0.231
(0.66)
AY, ,
0.250
(1.86)
-0.194
AY, 2
(1.52)
A Y ,,
-0.030
(0.26)
SAY,
0.026
(0.15)
Joint F-test, AY = 1.91
Joint F-test, AM = 9.59*
Joint F-test, AE = 3.00*
R2 = 0.628
DW = 2.146
SE = 3.87

'Absolute value of f-ratio
'Indicates significance at the 5 percent level

con v in cing u n less they are ro bu st over a b ro ad ch o ice
o f in stru m en ts. It can only be said that, based on th e
in stru m en ts used, th ere is n o evid ence o f sim u lta n e­
o us eq u ation bias in th e A-J eq uation.

Granger Causality Results
T h ere is ad ditional evid en ce th at th e A-J results
w ere n o t affected by sim u ltan eo u s eq u atio n bias.
Sim ultaneity requ ires tem p o ral feed back b etw een
m o n ey and in co m e. T hu s, th e lack o f G ranger (1969)
cau sality from in co m e to m oney is a n ecessa iy ,
th ou gh n o t sufficient, co n d itio n for statistical exogen eity .l!l W hen Elliott (1975) perfo rm ed tests o f G ranger
cau sality betw een m oney, in co m e and governm ent
exp en d itu res, he found u n id irectio n al cau sality ru n ­

19See Wu (1983) for a discussion of these issues.



OCTOBER 1986

nin g from m on ey to in co m e an d b id irectio n a l ca u sa l­
ity b etw een ex p en d itu res an d in co m e.2 M ore recently,
"
using th e original A-J data, B atten an d T h o rn to n (1985)
found u nid irectio n al cau sality ru n n in g from m o n ey to
in co m e an d no cau sal ord erin g b etw een in co m e and
exp en d itu res.
T h e fact th at in co m e d o es n o t G ran ger-cau se
m on ey im plies that the co efficien ts on th e d istribu ted
lag o f AM, do n ot reflect th e feed back o f in co m e on
itself via m oney; in stead , th e se co efficien ts m easu re
th e direct, an d po ssib ly in d irect, effects o f m o n ey on
th e eco n om y. T o verify th is in terp retation , a th reeq u arter d istribu ted lag o f AY w as in clu d ed in th e A-J
eq u ation as sep arate regresso rs an d th e sig n ifican ce of
th e se co efficien ts w as tested . T h e resu lts are rep o rted
in table 2. T h e co efficien ts on th e lags o f th e d e p e n ­
dent variable are not significantly different from zero
— individually or jointly. F u rth erm o re, th e co e f­
ficien ts on th e m oney an d ex p en d itu re variables differ
little from th e OLS resu lts o f table 1.

The Sims Evidence
A lthough h is criticism w as n o t d irected exp licitly at
th e A-J equation, Sim s (1980,1982) h as argued recen tly
that th e im p act o f m o n etary p o licy a ctio n s is very
sm all if in terest rates are in clu d ed in the sam e eq u a ­
tion .3 T o investigate S im s’ co n je c tu re , w e ad d ed a
1
co n tem p o ra n eo u s an d th ree-q u a rte r d istrib u ted lag o f
th e ch an g e in th e th ree-m o n th T reasu ry bill rate (ATB)
to th e A-J e q u a tio n .- T h e results, rep o rted in table 3,
show that only the co n tem p o ra n e o u s co efficien t on
ATB is significant. M oreover, th e co efficien ts on th e
m o n ey an d ex p en d itu re variables are little ch a n g ed
from th o se in table 1, an d n o n e o f th e qualitative
co n clu sio n s abou t th e effectiv en ess o f m o n eta iy or
fiscal p o licy a ctio n s is altered .
T h u s, as w as th e ca s e for allegation s o f m issp ecifica tion, th ere is co n sid era b le d isp arity b etw ee n th e c o n ­
ventional w isdom an d th e em p irical resu lts c o n c e rn ­
ing th e issu e o f sim ultan eity. N evertheless, th e claim
th at sim u ltan eity is a serio u s p rob lem for th e A-J
eq u ation is a d eeply en tre n c h e d an d w idely a ccep ted

“ Elliott used Sims’ (1972) procedure which requires that the data be
filtered, a process that can affect the test results. See Feige and
Pearce (1979).
2,McCallum (1983, 1986) has critiqued Sims’ results on theoretical
grounds.
“ The equation was also estimated with the level of the Treasury bill
rate; however, none of the qualitative conclusions were changed.

13

FEDERAL RESERVE BANK OF ST. LOUIS

criticism o f th e ir w ork.23 T h e evid en ce ex am in ed in
th is sectio n , how ever, su ggests that estim atio n o f the
original A-J eq u atio n w as n o t affected by sim ultaneity.

INAPPROPRIATE INDICATORS O F
PO LICY ACTIONS
A third m ajo r criticism o f th e St. Louis eq u atio n w as
th at A -J’s in d icators o f p o licy actio n s m ay be in ap p ro ­
priate. Failu re to u se ap p rop riate in d icato rs co u ld bias
th e estim ated param eter's, p erh ap s by d istorting the
relative im p o rtan ce o f m o n eta iy an d fiscal action s.-4
In a sen se, th is arg u m ent is an ex ten sio n o f the
policy en d o g en eity argum ent sin ce its p ro p o n en ts
co n ten d ed th at th e ap p rop riate in d icato r o f m on etary
p o licy sh o u ld n o t resp o n d en d o g en o u sly to forces
o u tsid e o f th e F e d ’s co n tro l. F or exam ple, in th e first
p u b lish ed criticism o f A-J, de Leeuw an d K alch b ren n e r (19G9) criticiz ed th e u se o f th e m o n eta iy b ase (and
im plicitly M l) as an in d ica to r o f m o n eta iy policy
a ctio n s on th e g rou n d s th at so m e o f its co m p o n e n ts
(particularly, cu rre n cy an d borrow ed reserves) w ere
en d o g en o u s an d n o t co n tro lled by th e F ed d irectly
In stead , de Leeuw and K alch b ren n er offered an alter­
native exo g en o u s policy m easu re th at th ey o btain ed
by su b tractin g cu rre n cy an d borrow ings from th e a d ­
ju sted m o n eta iy base. W hen they estim ated an A-J
type eq u atio n u sing th e ir m easu re o f m o n eta iy policy
actio n s, th ey fou nd th e cu m u lative m o n e ta iy policy
m u ltip lier w as m u ch sm aller th a n th a t o f th e A-J
eq u atio n an d n ot significantly d ifferent from zero. On
th e o th e r hand , th e ir estim ated cu m u lative govern­
m e n t sp en d in g m u ltip lier w as su bstan tially larger and
w as statistically significant.2’
1
In th e ir reply, A-J (1969) p o in ted o u t th a t d e Leeuw
an d K a lch b ren n er’s fo cu s o n th e u ses o f th e m o n eta iy
b a se w as in ap p ro p riate. A lthough th e banks an d the
p u b lic d eterm in e th e u ses o f th e base, th e Fed co n tro ls
th e size o f th e m o n eta iy b a se th rou gh its in flu en ce
over th e s o u rc e s o f th e base, th e largest co m p o n e n t of

?3While Andersen and Jordan acknowledged that money could be
endogenously related to income and expenditure variables via a
“ Fed reaction function,” they considered this to be of little practical
significance. See Andersen and Jordan (1969), p. 16.
24For some, the concern was that some of the effect of fiscal policy
might be incorrectly attributed to monetary policy. See Blinder and
Solow (1974).
25This line of argument was also taken by Gramlich (1971).
^Government receipts were also included; the estimated cumulative
multiplier of government receipts also increased but was statistically
significant only with longer lags.

14




OCTOBER 1986

Table 3
Estimates of the Andersen-Jordan
Equation with a Distributed Lag of
Interest Rates
Lags
AM
ATB
0
2.409*
4.216*
(3.07)
(2.37)
1
-0.633
0.122
(0.61)
(0.06)
2
2.124
0.199
(2.00)
(0.10)
3
0.737
-Q122
(0.79)
(0.07)
Sum
4.637*
4.415
(4.95)
(1.39)
Constant
2.910*
(3.47)
Joint F-test, AM = 7.65*
Joint F-test, ATB = 1.96
Joint F-test, AE =3.10*
R2 = .635
DW = 1.78
SE = 3.83

AE
0.313
(1.17)
0.639*
(2.32)
0.002
(0.01)
-Q666*
(2.47)
0.228
(0.94)

'Indicates statistical significance at the 5 percent level
Absolute value of the t-ratio in parentheses

w h ich is th e F e d ’s h old in g s o f U.S. gov ern m en t se c u ri­
ties. T h u s, th e F ed d eterm in es th e size o f th e m o n eta iy
b ase throu gh its sales o r p u rch a se s o f governm ent
secu rities.
Fu rth erm ore, A-J n o ted th at ch a n g es in th e M l
m o n ey stock d uring th e ir estim a tio n period w ere
d o m in ated by ch a n g es in th e m o n etary b a se. H ence,
th e Fed ex e rcised co n tro l over M l th rou g h its co n tro l
o f th e so u rces o f th e m o n etary b ase. S in ce th is e x ­
ch an ge, th e d isag reem en t over th e m e a su re m en t of
m o n etary p o licy a ctio n s h a s su b sid ed , a n d th e m o n e ­
tary b a se an d M l (and, at tim es, b ro a d e r m o n e ta iy
aggregates) are gen erally a ccep ted , an d co m m o n ly
u sed , as in d ica to rs o f p o licy actio n s.
A -J’s m ea su rem en t o f fiscal p o licy a ctio n s w as criti­
cized m ore th an th e ir m easu re o f m o n e ta iy policy
a ctio n s. R ecogn izin g th at ce rta in co m p o n e n ts o f b o th
fed eral govern m en t ex p en d itu res an d reven u es re ­
sp o n d en d o g en o u sly to th e level o f e c o n o m ic activity,
A-J u tilized h ig h -em p loy m en t m easu res, w h ich w ere
a d ju sted for th e se in flu en ces. De L eeuw a n d K alch -

FEDERAL RESERVE BANK OF ST. LOUIS

OCTOBER 1986

b re n n e r co n ten d ed that th is a d ju stm en t w as in c o m ­
plete b eca u se it failed to elim in ate th e in flu en ce of
inflation. T h e su b stitu tio n o f in flatio n -ad ju sted , highem p loy m en t govern m ent ex p en d itu res an d revenues,
how ever, h ad little im p act on th e estim ated p ara m e­
ters o f th e eq uation.

Subsequently, how ever, Sch m id t an d W aud (1973)
found th at C orrigan’s resu lts d ep en d ed critically on
th e polynom ial re strictio n s h e im p o sed .2 W h en th ese
"
restrictio n s, w h ich a p p eared to b e re je cte d by th e
data, w ere relaxed, Sch m id t an d W aud obtain ed
resu lts w ith th e IS m easu res th at w ere sim ilar to A -J’s.

G ram lich (1971) felt th at the n o n -m o n e ta iy "exo g e­
n o u s ” in flu en ces w ere too narrow ly d efined . C o n se­
quently, h e co n stru cte d two b ro ad er co m p o site m ea ­
su res. His ex p en d itu re m easu re w as governm ent
p u rch ase s plus exports, g ran ts-in -aid and an invento iy a d ju stm en t for d efen se p u rch a se s. His revenue
m easu re in clu d ed hig h -em p loy m ent p erso n al taxes
plus in terest pay m en ts and social secu rity co n trib u ­
tio n s le ss exo g en o u s tran sfers (that is, all transfers
excep t u n em p loy m en t co m p en satio n ). W hile th ese
ch a n g es did result in larger (and m ore nearly sta tisti­
cally significant) su m s o f estim ated co efficien ts for the
n o n -m o n e ta iy in flu en ces, th e gen eral resu lts o f A-J
rem ain ed in tact.

T h e evid ence suggests th at A -J’s resu lts co n cern in g
th e effect o f fiscal p o licy w ere n o t critically d ep e n d en t
on th e ir m ea su rem en t o f m o n etary o r fiscal policy
a ctio n s. M eyer an d R a sch e (1980) su m m arized th eir
investigation o f th is issu e by n o tin g that, “th e m od i­
fication s suggested . . . have n o t g en erally resu lted in
d ram atic ch an g es in th e estim a ted m u ltip liers in sim ­
ple red u ced -fo rm eq u a tio n s.”2
”

C orrigan (1970) offered w hat ap p eared to be th e
m ost dam aging criticism o f th e h igh -em ploym ent
m easu res o f fiscal policy actio n s. He argued th at they
did n ot rep resen t ap p rop riate in d icato rs o f d isc re ­
tionary fiscal policy actio n s, sin c e hig h -em p loy m en t
m easu res (especially revenues) w ou ld ch an g e w ith
h ig h -em p loy m en t in co m e. In th e ir p lace, h e offered
h is initial stim u lu s (IS) m easu re o f d iscretio n a iy
ch a n g es in fiscal policy. T h e IS m easu re o f governm ent
ex p en d itu res did not differ significantly from th e highem p lo y m en t m easu re. T h e IS m easu re o f revenu es, on
th e o th e r han d , differed co n sid erab ly from its high
em p lo y m en t co u n terp art. In p articu lar, th e IS m ea ­
su re o f a ch an g e in governm ent revenu es w as n o n z ero
only in qu arters in w h ich a tax w as in tro d u ced , m o d i­
fied, su sp en d ed o r elim in ated .
W h en IS m easu res w ere su b stitu ted for highem p loy m ent m easu res in an A-J type eq u ation , th e
resu lts w ere startling: the estim ated cu m u lative im ­
pact o f ch an g es in M l d eclin ed , w hile th o se o f b o th
ch an g es in governm ent ex p en d itu res and o f ch an g es
in governm ent reven u es ro se significantly and, m ore
im portantly, w ere ap p aren tly statistically sign ifican t.2
7
T h u s, Corrigan co n clu d e d th at fiscal p o licy actio n s
had a m eaningful im p act on n om in al e co n o m ic
activity.

27Corrigan did not report t-statistics or standard errors for the summed
coefficients. Assuming that the estimated coefficients are uncorre­
lated, one obtains a t-statistic of 3.01 for testing the hypothesis that
the XE = 0 and a t-statistic of 9.46 for testing that XT = 0. Both of
those are statistically significant at the 5 percent level.



INAPPROPRIATE RESTRICTIO N S
To estim ate th e ir d yn am ic sp ecificatio n , A-J u sed
A lm on’s (1965) polyn om ial d istrib u ted lag estim atio n
te ch n iq u e th at w as d esign ed to im prove th e p recisio n
o f th e estim ated p aram eters o f a d istribu ted -lag
m odel. T h e te ch n iq u e co n stra in s th e p aram eters of
e a ch d istribu ted lag to lie on a polynom ial o f a given
d egree. P erh ap s b ec a u se relatively little w as know n
abou t th e p ro ced u re w h en A-J p u b lish ed th e ir paper,
critics co n ten d ed th at th e A-J resu lts m igh t b e d ep e n ­
d en t u pon, o r at least sensitive to, th e ir c h o ic e o f lag
length or polynom ial d egree."1
T h ere have b ee n relatively few investigations o f th is
a sp e ct o f th e A-J eq u atio n . T h e best-kn o w n stu d y by
Sch m id t an d W aud (1973), as w ell as o th ers by C orri­
gan, de Leeuw and K a lch b ren n er, an d Silber, focu sed
prim arily on th e selectio n o f th e lag length. B eca u se
th e se stud ies h eld th e polyn om ial degree fixed, how -

28The restrictions forced the estimated parameters of each distributed
lag to lie on a second degree polynomial.
^Meyer and Rasche (1980), p. 59. McCallum (1986), p. 14, simply
notes that “if there is a fiscal policy measure that carries a strongly
significant sum of coefficients in an equation of the St. Louis form, its
existence has not been well publicized.”
“ Specifically, if the lag length is too long or the polynomial degree too
high, estimated parameters are unbiased but inefficient. Alterna­
tively, if the lag length is too short or the polynomial degree is too
low, the estimates are biased. Therefore, it is important that the
appropriate lag length and polynomial degree be determined. The
parameters will also be biased if the chosen lag is too long and
exceeds the true lag by more than the true polynomial degree and
may be biased even if it exceeds the true lag by an amount less than
or equal to the true polynomial degree. See Batten and Thornton
(1983) for a discussion of this and other issues, and for other
references.

15

FEDERAL RESERVE BANK OF ST. LOUIS

ever, th ey did n o t analyze co m p letely th e restrictio n s
im p o sed by th e A-J sp ecificatio n .3
1
W h en Elliot (1975) exam in ed th e lag stru ctu re and
th e polyn om ial restrictio n s separately, h e co n clu d e d
th at A-J resu lts w ere n o t p articu larly sensitive to lag
stru ctu re o r to th e polynom ial restrictio n s. His c o n ­
clu sion, how ever, w as n ot b ased on statistical tests. He
m erely co m p ared p aram e te r estim ates for different
lag stru ctu res an d polynom ial degrees. M ore recently,
B atten an d T h o rn to n (1983) perform ed a system atic
exam in ation o f th e sp ecificatio n o f the A-J equation
u sin g re ce n t data, an d B atten an d T h o rn to n (1985)
perform ed a sim ilar analysis u sin g th e original A-J
data. T h ey co n clu d e d th at th e p olicy-relevant resu lts
of A-J do not d ep en d on th e ir c h o ice o f lag length or
polynom ial degree.

SUMMARY AND CONCLUSIONS
L eonall C. A n d ersen ’s b est k now n an d m o st signifi­
ca n t co n trib u tio n to e c o n o m ics is h is collaborative
re sea rch w ith Jerry L. Jo rd an , w h ich resu lted in p u bli­
ca tio n o f th e A-J eq u atio n . F o r a perio d o f nearly 20
y ears, it h as b e e n th e su b je ct o f m u ch in tere st an d
co n sid erab le critic ism .1 Few o th e r p ie ce s o f applied
eco n o m ics, if any, have b een so th orou ghly d iscu ssed ,
analyzed an d investigated.

OCTOBER 1986

u nknow n o r unavailable w h en A n d ersen an d Jo rd a n 's
critics w ere m o st vocal. F u rth erm o re, so m e o f the
criticism s are valid w h en ap p lied to sam p le p erio d s
b eyond that exam in ed by A n d ersen an d Jo rd a n .*1
T h e se facts n otw ith stan d in g, th is review v in d icates
A n d ersen an d Jo rd a n o f an y serio u s b re a c h o f th e
stan d ard s o f e c o n o m e tric p ra c tice an d su ggests that,
in reality, it w as n ot th e ir a p p lica tio n o f e co n o m etric
m eth o d s th at w as co n troversial, b u t th e ir resu lts.34
A n d ersen an d Jo rd a n sh o u ld b e co n g ra tu la ted for
providing o n e o f th e m o st stable, lastin g an d robu st
eq u atio n s in ap p lied e c o n o m ics. In o u r o p in ion , h o w ­
ever, th e ir m o st im p o rtan t co n trib u tio n is th at they
sh ook th e fou n d ation s o f co n v en tion al ec o n o m ic
thou ght an d su b je cte d th e resu lts o f stan d ard applied
ec o n o m ics to c lo se r scru tin y. T h is fo rced e co n o m ists
an d p olicym akers to take a c lo se r look at th e issu e of
th e efficacy o f m o n eta iy an d fiscal policy.

R EFE R E N C E S

O ur review o f th e original A n d ersen -Jo rd an study
an d th e criticism th at em erg ed follow ing its p u b lica ­
tion p o in ts out th e obvious, bu t seld om articu lated ,
fact th at all o f th e criticism s o f A nd ersen an d Jo r d a n ’s
w ork apply equally w ell to m u ch o f th e ap p lied e c o ­
n o m ic re se a rc h o f th at tim e, an d even today. W e also
n o te th at A n d ersen and Jo rd a n w ere aw are o f m an y of
th e caveats o f th e ir w ork an d took p re ca u tio n s against
th em . M ost im portantly, u sin g th e ir original data, w e
te ste d th e A n d ersen -Jo rd an eq u atio n for m issp ecificatio n an d sim u ltan eo u s-eq u atio n bias. W e find th at
n o n e o f th e o ft-cited criticism s o f th e ir eq u atio n is (or
co u ld have been) su b stan tiated by th e se statistical
tests. G ranted, som e o f th e te ch n iq u e s u sed w ere

Almon, Shirley. “The Distributed Lag Between Capital Appropria­
tions and Expenditures,” Econometrica (January 1965), pp. 17896.
Andersen, Leonall C. “Money Market Conditions as a Guide for
Monetary Management,’’ in Karl Brunner, ed., Targets and Indica­
tors of Monetary Policy (Chandler, 1969).
Andersen, Leonall C., and Jerry L. Jordan. “Monetary and Fiscal
Actions: A Test of Their Relative Importance in Economic Stabili­
zation— Reply,” this Review (April 1969), pp. 12-16.
_________ “Monetary and Fiscal Actions: A Test of Their Relative
Importance in Economic Stabilization,” this Review (November
1968), pp. 11-24.
Batten, Dallas S., and Daniel L. Thornton. “The Andersen-Jordan
Equation Revisited,” Journal of Macroeconomics (Summer 1985),
pp. 419-32.
________ _ “ Polynomial Distributed Lags and the Estimation of the
St. Louis Equation,” this Review (April 1983), pp. 13-25.
Blinder, Alan S., and Robert M. Solow. “Analytical Foundations of
Fiscal Policy,” in The Economics of Public Finance (Brookings
Institution, 1974), pp. 3-115.
Carlson, Keith M. “Does the St. Louis Equation Now Believe in
Fiscal Policy?” this Review (February 1978), pp. 13-19.

31After the polynomial degree has been chosen, alternative lag speci­
fications amount to imposing polynomial restrictions on different
parameter spaces. Consequently, the restrictions implied by differ­
ent lag specifications are not nested within each other when the
polynomial degree is fixed.
32One of the most recent additions to this literature, Raj and Siklos
(1986), applies spectral analysis to the Andersen-Jordan equation
for the period 1/1947 to IV/1984. Again the results are consistent with
those of A-J.

:liFor example, Thornton and Batten (1985) find bidirectional Granger
causality between money and income over the period from 11/1962
to 111/1982.
14It is interesting to note the similarities between the A-J equation and
Granger’s (1969) and Sims’ (1972) examination of causal ordering.
Furthermore, except for the exclusion of the own distributed lag of
the dependent variable, the A-J equation closely resembles the now
frequently used and commonly accepted vector autoregression
model.

16




FEDERAL RESERVE BANK OF ST. LOUIS

Chow, Gregory C. “On the Long-Run and Short-Run Demand For
Money,” Journal of Political Economy (April 1966), pp. 111-31.
Cooley, Thomas F., and Stephen F. LeRoy. “ Identification and
Estimation of Money Demand,” American Economic Review (De­
cember 1981), pp. 825-44.
Corrigan, E. Gerald. “The Measurement and Importance of Fiscal
Policy Changes,” Federal Reserve Bank of New York Monthly
flewew (June 1970), pp. 133—
45.
Darby, Michael R. “Comments on Modigliani and Ando,” in Jerome
L. Stein, ed., Monetarism, vol. 1, Studies in Monetary Economics
(North-Holland, 1976), pp. 67-68.
Davis, Richard G. “How Much Does Money Matter? A Look at
Some Recent Evidence,” Federal Reserve Bank of New York
Monthly Review (June 1969), pp. 119-31.
de Leeuw, Frank, and John Kalchbrenner. “Monetary and Fiscal
Actions: A Test of Their Relative Importance in Economic Stabili­
zation — Comment,” this Review (April 1969), pp. 6-11.
Duesenberry, J. S., G. Fromm, L. R. Klein, and E. Kuh, eds. The
Brookings Quarterly Econometric Model of the United States (RandMcNally, 1965).
Elliott, J. W. “The Influence of Monetary and Fiscal Actions on Total
Spending,” Journal of Money, Credit, and Banking (May 1975), pp.
181-92.
Feige, Edgar L., and Douglas K. Pearce. “The Casual Causal
Relationship Between Money and Income: Some Caveats for
Time Series Analysis,” Review of Economics and Statistics (No­
vember 1979), pp. 521-33.
Friedman, Benjamin M. “ Even the St. Louis Model Now Believes in
Fiscal Policy,” Journal of Money, Credit, and Banking (May 1977),
pp. 365-67.
Friedman, Milton, and David Meiselman. “The Relative Stability of
Monetary Velocity and the Investment Multiplier in the United
States, 1897-1958,” in The Commission on Money and Credit,
Stabilization Policies (Prentice-Hall, 1963), pp. 165-268.
Fomby, Thomas B., R. Carter Hill, and Stanley R. Johnson. Ad­
vanced Econometric Methods (Springer-Verlag, 1984).
Gordon, Robert J. “Comments on Modigliani and Ando," in Jerome
L. Stein, ed., Monetarism, vol. 1, Studies in Monetary Economics
(North-Holland, 1976), pp. 52-66.
Gramlich, Edward M. “The Usefulness of Monetary and Fiscal
Policy as Discretionary Stabilization Tools,” Journal of Money,
Credit, and Banking (May 1971), pp. 506-32.
Granger, Clive W. J. “Investigating Causal Relations by Econo­
metric Models and Cross-Spectral Methods,” Econometrica (July
1969), pp. 424-38.
Klein, L. R. “Comments on Modigliani and Ando,” in Jerome L.
Stein, ed., Monetarism, vol. 1, Studies in Monetary Economics
(North-Holland, 1976), pp. 50-51.




OCTOBER 1986

McCallum, Bennett T. “Monetary Versus Fiscal Policy Effects: A
Review of the Debate,” in R. W. Hafer, ed., The Monetary Versus
Fiscal Policy Debate: Lessons From Two Decades, Studies in
Monetary and Macroeconomic Theory and Policy (Rowman and
Allanheld, 1986), pp. 9-29.
_________ “A Reconsideration of Sims' Evidence Concerning
Monetarism,” Economic Letters (vol. 13, nos. 2-3,1983), pp. 16771.
Meyer, Lawrence H., and Robert H. Rasche. “Empirical Evidence
on the Effects of Stabilization Policy,” in Stabilization Policies:
Lessons from the '70s and Implications for the ’80s (Washington
University in St. Louis, Center for the Study of American Business,
Working Paper No. 53, 1980), pp. 41-112.
Modigliani, Franco, and Albert Ando. “ Impacts of Fiscal Actions on
Aggregate Income and the Monetarist Controversy: Theory and
Evidence,” in Jerome L. Stein, ed., Monetarism, vol. 1, Studies in
Monetary Economics (North-Holland, 1976), pp. 17-42.
Raj, Baldev, and Pierre L. Siklos. “The Role of Fiscal Policy in the
St. Louis Model: An Evaluation and Some New Evidence,” Journal
of Applied Econometrics (1986), pp. 287-94.
Ramsey, James B., and Peter Schmidt. “Some Further Results on
the Use of OLS and BLUS Residuals in Specification Error Tests,”
Journal of the American Statistical Association (June 1976), pp.
389-90.
Schmidt, Peter, and Roger N. Waud. “The Almon Lag Technique
and the Monetary Versus Fiscal Policy Debate,” Journal of the
American Statistical Association (March 1973), pp. 11-19.
Schwartz, Anna J. “Comments on Modigliani and Ando,” in Jerome
L. Stein, ed., Monetarism, vol. 1, Studies in Monetary Economics
(North-Holland, 1976), pp. 43-49.
Silber, William L. "The St. Louis Equation: Democratic' and Re­
publican’ Versions and Other Experiments,” Review of Economics
and Statistics (November 1971), pp. 362-67.
Sims, Christopher A. “Policy Analysis with Econometric Models,”
Brookings Paper on Economic Activity (1:1982), pp. 107-52.
________ _ “Comparison of Interwar and Postwar Business Cy­
cles: Monetarism Reconsidered,” American Economic Review
(May 1980), pp. 250-57.
_________ “Money, Income, and Causality,” American Economic
Review (September 1972), pp. 540-52.
Thornton, Daniel L., and Dallas S. Batten. “ Lag-Length Selection
and Tests of Granger Causality Between Money and Income,”
Journal of Money, Credit, and Banking (May 1985), pp. 164-78.
Wu, De-Min. “Tests of Causality, Predeterminedness and Exoge­
neity," International Economic Review (October 1983), pp. 547-58.
_________ “Alternative Tests of Independence Between Stochas­
tic Regression and Disturbances,” Econometrica (July 1973), pp.
733-50.

17

FEDERAL RESERVE BANK OF ST. LOUIS

OCTOBER 1986

A M onetarist Model for Econom ic
Stabilization: Review and Update
Keith M. Carlson

I n APRIL 1970, Leonall A nd ersen and I p u blish ed an
article, "A M o n etarist M odel for E co n o m ic Stabiliza­
tio n ," in th is Review.' In this article, w e developed a
sm all m od el o f th e U.S. eco n o m y p u rp o rtin g to explain
th e m ovem ents o f ce rta in key e c o n o m ic aggregates,
nam ely, n o m in al GNP, o u tp u t (real GNP), p rices, u n ­
em p loy m ent and sh o rt- an d long-term in terest rates.
T h e m o d el's fo cu s w as on th e role o f m o n etary aggre­
gates, in particu lar, M l, in th e d eterm in atio n o f th ese
e co n o m ic variables.
T h e p u rp o se o f th e p re se n t article is to review th is
m od el in light o f d evelop m en ts sin c e 1970. T h is review
beg ins w ith a d iscu ssio n o f th e d evelop m en t o f th e
original m odel an d is follow ed by an exp lan atio n o f
th e key d ifferences betw een it an d th e cu rre n t v ersion
o f th e m od el. T h is cu rre n t version is analyzed by
d em o n stratin g its re sp o n se to sh o ck s an d its ability to
sim ulate, e * post, m ovem ents o f n o m in al GNP, output,
p rices, u nem p loy m en t an d in tere st rates.

OUR EARLY A TTEM PT AT MODELING
In 1970, m a cro e co n o m ic m od el-bu ild in g w as a p o p ­
u lar ex ercise. T h e M ichigan an d W h arton m odels,
w h ich h ad existed for a n u m b er o f y ears, w ere c o n tin ­
ually bein g m odified an d updated.- T h e FRB-M IT
m odel, first p u b lish ed in 1968, w as still bein g refin ed :'
T h e D ata R eso u rces m o d el w as in th e d evelopm ent

'Andersen and Carlson (1970).
2See Klein and Burmeister (1976), pp. 188-210 and pp. 248-70.
3de Leeuw and Gramlich (1968 and 1969).



18

stage.4 E a ch o f th e se m o d els co n ta in e d a large n u m b er
o f eq u atio n s an d fo cu sed o n a secto ra l breakd ow n of
GNP derived from th e K eynesian a p p ro a ch to GNP
d eterm in ation.
Andy an d I felt th at th e se m o d els did n o t place
p ro p er em p h a sis on th e role o f m o n e ta iy a ctio n s.
Furth erm ore, th ey focu sed prim arily on th e sh o rt run
— a p ro jectio n h o rizo n of, at m ost, several qu arters.
W e w an ted a m o d el th a t m oved from th e sh o rt-ru n to
a lon g-run d yn am ic eq u ilibriu m w ith a p p rop riate re c ­
ognition bein g given to initial co n d itio n s in this p ro ­
cess. In addition, w e w an ted a m o d el th at w as sm all
en ou gh th at th e in terrela tio n sh ip s am o n g th e vari­
ables co u ld b e u n d ersto o d easily. M oreover, w e
sought to bu ild on existin g re sea rch at th is Bank,
com bin in g various resu lts to sh ed light on th e issu e of
e co n o m ic stab ilization in a w ay th at w ou ld overcom e
som e o f th e sh o rtco m in g s o f larg e-scale K eynesianstyle m odels.
O ur co n c e rn s abou t th e sta te o f m od el-bu ild in g
strongly in flu en ced o u r efforts to develop an a ltern a ­
tive m a cro e co n o m ic m od el o f th e U.S. eco n o m y . We
w ere n o t co n c e rn e d abou t resp ecifyin g behavioral
eq u atio n s (for exam ple, co n su m p tio n , in vestm en t,
etc.); rath er, w e w an ted to ca p tu re em p irica l re la tio n ­
sh ip s b etw een a relatively few key m a c ro e co n o m ic
variables th at w ere im p licitly g ro u n d ed in ec o n o m ic
theory.
T h e fu n d am en tal b u ild in g block o f o u r m o d el w as
th e A n d ersen -Jo rd an (A-J) eq u atio n , w h ich fo cu sed on

4Klein and Burmeister (1976), pp. 211-31.

FEDERAL RESERVE BANK OF ST. LOUIS

th e two ch ie f arm s o f policym aking, m o n eta iy and
fiscal actio n s.5 Although th is eq u atio n did not provide
a m od el o f GNP d eterm in atio n , it w as useful in fore­
castin g and in policy sim u lation s. In th e A-J eq uation,
GNP w as “d eterm in ed ” solely by cu rren t and past
m o n eta iy an d fiscal policy actio n s; o th e r in flu en ces
on GNP w ere fou nd to be ran d o m d uring the sam p le
period investigated bv A n d ersen -Jo rd an .
A n o th er im p o rtan t bu ilding block in th e c o n s tru c ­
tion o f th e A n d ersen -C arlson (A-C) m o d el w as the
in te re st rate e q u a tio n , d ev elo p ed by Y oh e an d
Karnosky in 1969, in w h ich in terest rates w ere sy stem ­
atically related to past inflation.1 T h e ir resu lts w ere
'
co n siste n t w ith th e F ish erian th e o iy o f in tere st in th at
they sh o w ed th at inflation prem ia are in co rp o ra ted
into n o m in al in tere st rates.
To co m p lete th e m odel, w e n eed ed eq u atio n s for
the u nem p loy m en t rate and th e p rice level. T h e m ost
fam ous and generally a cc e p te d u n em p loy m en t rate
eq uation, developed by A rthur Okun, w as easily m o d i­
fied for o u r p u rp o ses.7 T h is eq u atio n co m b in es a given
p o ten tial GNP w ith actu al GNP to provide an estim ate
o f th e u nem p loy m en t rate.
Finding an ap p rop riate p rice eq u atio n w as a m ore
ch allengin g task. M ost large m o d els u sed a w agem arkup eq u atio n and, in so m e cases, som e type o f
Phillips curve eq u atio n . T h e se eq u atio n s did not fulfill
o u r req u irem en ts. Instead , w e developed a p rice eq u a ­
tio n th at co m b in ed th e Phillips curve resu lts w ith
p rice exp ectation s.'1 W e u sed th e co efficien ts on the
inflation term s in th e long-term in tere st rate eq u atio n
as o u r m easu re o f p rice ex p ectatio n s. We th o u gh t o u r
a p p ro ach w as novel, an d it seem ed to w ork qu ite
satisfactorily at th e tim e. In retro sp ect, it seem s ru d i­
m en tary and has not w orked as well in re ce n t y ears.

T H E ORIGINAL SPECIFICATION AND
SUBSEQUENT CHANGES

OCTOBER 1986

eq u a tio n s an d
in clu d ed .

th e

ex o g en o u s variables

th at are

T h e original an d cu rre n t v ersion s o f th e A-C m od el
are su m m arized in table 1. T h e m od el still has the
sam e n u m b er o f key en d o g en o u s variables; however,
th e th ree GNP variables — total spen din g, o u tp u t and
p rices — are now sp ecified in rates o f ch a n g e in stead
of first differences. T h is ch a n g e w as m ad e in th e 1970s,
w h en th e first-d ifferen ce form beg an to exhibit h etero skedasticity.-’ In any event, th e rate-of-ch an g e form is
ea sier to interp ret, an d th e fu n d am en tal p ro p erties of
th e m odel are u n ch an g ed . M o n etaiy a ctio n s have a
sh o rt-ru n effect on o u tp u t an d a lon g-run effect on
p rices; fiscal a ctio n s have little effect on o u tp u t or
p rices in eith e r th e sh o rt- o r long-run.
A nother ch an g e w as the ad d itio n o f tw o m o re exog­
en o u s variables — energy p rice s an d exp orts. T his
ch an ge, n ecessita ted by d ev elo p m en ts in th e 1970s,
w as a cru d e w ay to in co rp o ra te su ch co m p lex fa c­
tors."’ N evertheless, it en a b led us to keep th e m odel
sm all. Fu rth erm ore, ch a n g es in energy p rice s also
e n ter th e cu rren t m od el th rou gh th eir in flu en ce on
poten tial GNP.
A nother change, n ot sh ow n explicitly in table 1, is
the red efin ition o f tw o exo g en o u s variables — p o te n ­
tial GNP and federal ex p en d itu res. P oten tial GNP is
now estim ated u sin g p ro d u ctio n -fu n ctio n m eth o d s
developed by R asch e an d T a to m ." Fed eral ex p en d i­
tu res are now cyclically a d ju sted ra th er th an highem p lo y m en t.1 T h e ratio n ale u nd erlyin g th e fiscal
2
m easu re rem ain s th e sam e — to co n stru c t a m easu re
o f federal sp en d in g th at ex clu d e s th e cy clical effect of
the eco n o m y on th e budget.
Finally, in th e cu rre n t version, th e p rice, lon g-term
in terest rate an d u n em p loy m en t eq u a tio n s are ad ­
ju sted for au to co rrelatio n to avoid b iasin g th e e sti­
m ated stand ard erro rs o f th e coefficien ts.

T h e original m odel w as recursive, w ith th e p articu ­
lar form o f ea ch eq u atio n d eterm in ed , for the m ost
part, by th e data. Sin ce 1970, several ch an g es have
b een m ade in th e m od el in term s o f th e form o f th e

Although th ese ch a n g es m ake it im p o ssib le to co m ­
pare m eaningfully th e su m m ary sta tistics for th e two
versions, the two v ersions sh o w sim ilar estim a tes of
th e im p a ct o f m o n e ta iy a n d fisca l a ctio n s . An
eq u atio n -b y -equ atio n co m p a riso n is su m m arized in
th e sh ad ed in sert on page 21.

5Andersen and Jordan (1968).
6Yohe and Karnosky (1969).
70kun (1962).
8See Considine (1969).

9Carlson (1978).
10Rasche and Tatom (1977b).
"Rasche and Tatom (1977a).
12de Leeuw and Holloway (1983).




19

FEDERAL RESERVE BANK OF ST. LOUIS

OCTOBER 1986

Table 1
St. Louis Model: Original vs. Current Version
Original version
Sample period: 1/1953-IV/1969
(1) Total spending equation
4
4
AY, 2.67 2 mAMt_, 2 e,AE,,,
i= 0
i 0
=

+

+

=

Current version
Sample period: 1/1960-1V/1984
(1) Total spending equation
3
Y, = 3.08 - 4.28Z1, + 2 m,M,
i= 0
4

-i

3

+ 2 e,E,_i 2 ex,EX,,,
i= 0
i= 0
2m, .96 2e, .07 2ex, .00
R2 .32 SE 3.91 DW 2.22
(2) Price equation
3
P, .96 2 pe,PE,_,
i= 0
5
2 d,D,_i 1.68PA,
i= 0
- .96Z2, .80Z3,
2pei .09 2d, = 08 p -.01
R2 = .77 SE = 1.48 DW = 1.98
+

2m, 5.57 2e, .05
R2 .66 SE 3.84 DW 1.75
(2) Price equation
5
AP, = 2.70 + 2 dp,., + .86 APA,
i= 0
=

=

=

=

=

=

=

=

=

=

=

=

+

+

+

+

2d, .09
R2 .87 SE 1.07 DW 1.41
(3) Demand pressure identity
D, = AY, - (XF, - X,.,)
(4) Total spending identity
AY, = AP, + AX,
(5) Long-term interest rate equation
RL, = 1.28 - .06M, + 1 42Z,
16
16 p
+
2 X , * ,. , + 2 p ,( ' )
i= 0
i = 0 U '- '/4
2x, = .20 2pi = .96
R2 = .92 SE = .28 DW = .69
(6) Anticipated price definition
17 p
A P A ,-Y ,_2([( 2 p
).01 + 1 ]'« -1 )
i = 1 U'-'/4
2p, = .96
=

=

=

=

=

=

(3) Demand pressure identity
D, = X, - ([(XF,/X,_,)< - 1]100)
(4) Total spending identity
Y, = P, + X,
(5) Long-term interest rate equation
20
RL, = 5.66 + 2 p,P,_,
i= 0
2p, = .55
R2 = .07

p, = 1.15 p2 = -.1 6
SE = .42 DW - 1.96

(6) Anticipated price definition
21
PA, = 2 p,P,_,
i= 1
2p, = .55

(7) Unemployment rate equation
U, = 3.90 + .04G, + 28G,_,
R2 = .92 SE = .30 DW = .60
(8) GNP gap identity
XF, - X,
G'= XF, -1 0 0

20

(7) Unemployment rate equation
U, - UF, = .29G, + 16G,_,
p, = 1.20 P2 = 0.33
R2 = .71 SE = .21 DW = 1.95
(8) GNP gap identity
XF, - X,
G'= XF, -10°




FEDERAL RESERVE BANK OF ST. LOUIS

OCTOBER 1986

The St. Louis Model: Original vs. C urrent V ersions
T h e total sp en d in g eq u atio n h as b ee n ch an g ed
from a first-difference to a rate-of-ch an g e form , and
the rate o f ch an g e o f exp orts and a dum m y variable,
d esigned to cap tu re in a cru d e w ay th e velocity shift
after 1981, have b ee n ad d ed. T h e lag o n m o n ey w as
also sh o rten ed by o ne quarter.
In th e cu rren t version, th e p rice eq u atio n h as
th ree additional variables and is now in rate-ofch an g e form. Energy p rices are now in clu d ed as an
in d ep en d en t variable, and d um m y variables re p re­
sen tin g p rice co n tro l an d d eco n tro l in th e early
1970s are also inclu d ed . T h e d em an d p ressu re vari­
able (equation 3) has b een redefined to avoid m ix­
ing n om in al an d real variables. D em and p ressu re is
defined n ow as actu al o u tp u t grow th relative to its
poten tial to expand. T h e co efficien t on an ticip ated
prices, 1.68, now appeal's out o f line w ith both
th eo retical and past em p irical estim ates. However,
w h en th e sum for P in the long-term in terest eq u a ­
tion, .55, is taken into acco u n t, th e p ro d u ct o f the
two co efficients, (1.68 X .55), is m ore in lin e w ith
th eo retical exp ectation .
Unlike th e rest o f th e eq u atio n s, th e long-term

in terest rate eq u atio n is essen tially u n ch an g ed .
Sin ce its sole fu n ctio n is to g en erate th e w eigh ts on
past p rices to u se in th e m easu re o f an ticip ated
p rices, th e resu lts for th e early version h ad c o n sid ­
erable appeal b ec a u se 2 p , w as clo se to o n e. T his
result is n ot observed in th e cu rren t version. Al­
though th e form o f th e eq u atio n is n ow m u ch
sim pler, th e fit o f th e eq uation, w h ich in clu d es an
a u to co rrelatio n a d ju stm en t, is veiy poor. T h e good
fit o f th e original resu lt w as m islead in g b e c a u se th e
resid u als w ere highly co rrelated .
T h e seem ingly m a jo r ch a n g e in th e form o f eq u a ­
tion 6, w h ich d efines a n ticip a te d inflation, resu lts
from th e ch an g e from first-d ifferen ce to rate-ofch an g e form . T h e cu rren t version is m u ch ea sier to
in terp ret, bein g sim ply a w eigh ted sum o f past rates
o f p rice ch an g es.
F in a lly , th e u n e m p lo y m e n t e q u a t io n h a s
ch an g ed only slightly. E ssen tially, th e co n sta n t in
th e original version h as b ee n rep laced by th e fullem ploym ent u nem p loy m en t rate. T h is rate is in ­
ten d ed to b e co n siste n t w ith the estim a te o f p o te n ­
tial GNP.

Table 1 Continued ...
Symbols:
A = change in dollar values (note: AP, = X,_, (P, - P,_,) and
AX, = P,_,(X, - X,.,))
• = annual rate of change in variable
Y, = total spending (GNP in current prices)
M, = money stock (M1)
E, = federal expenditures (high-employment in original model
and cyclically adjusted in current model)
EX, = Exports of goods and services (in current prices)
P, = GNP deflator (1958 = 1.00 in original model and
1982 = 1.00 in current model)
D, = demand pressure
PA, = anticipated price level
XF, = potential output (Council of Economic Advisers’ estimate in
1958 prices in original model and Rasche-Tatom estimate
in 1982 prices in current model)




X, = output (GNP in 1958 prices in original model and GNP in
1982 prices in current model)
PE, = relative price of energy
RL, = corporate Aaa bond rate
U, = civilian unemployment rate
G, = GNP gap as a percent of potential output
Z, = dummy variable (1/1955-IV/1960 = 0; 1/1961-IV/1969 = 1)
Z1, = dummy variable (1/1960-IV/1981 = 0; 1/1982-IV/1984 = 1)
Z2, = price control dummy (1/1960-11/1971,11/1973-IV/1984 = 0;
111/1971-1/1973 = 1)
Z3, = post-price control dummy (1/1960-1/1973, 11/1975-IV/1984
= 0; 11/1973-1/1975 = 1)

21

OCTOBER 1986

FEDERAL RESERVE BANK OF ST. LOUIS

Table 2
The Current Model’s Response to a Fiscal Shock
(shocked values denoted by prime)

Quarters
elapsed
1
2
3
4
5
6
7
8
12
16
20
24
28
32
36
40

Exogenous variable
EVE
1.0454
1.0440
1.0444
1.0445
1.0457
1.0461
1.0454
1.0455
1.0458
1.0479
1.0467
1.0436
1.0424
1.0391
1.0422
1.0412

Y/Y
1.0025
1.0035
1.0032
1.0030
1.0036
1.0036
1.0036
1.0035
1.0036
1.0037
1.0036
1.0034
1.0033
1.0031
1.0032
1.0032

x/x
1.0022
1.0027
1.0035
1.0017
1.0028
1.0029
1.0025
1.0020
1.0000
.9998
.9983
.9988
.9977
.9984
.9990
1.0002

Endogenous variables
P/P
1.0001
1.0002
1.0005
1.0008
1.0011
1.0014
1.0018
1.0022
1.0033
1.0041
1.0047
1.0050
1.0051
1.0046
1.0039
1.0033

U'-U
-.061
-.107
-.137
-.099
-.105
-.125
-.116
-.095
-.004
.020
.067
.049
.082
.067
.046
-.008

RL'-RL
.001
.004
.009
.015
.020
.026
.033
.038
.053
.056
.053
.040
.025
.003
-.015
-.026

NOTE: To calculate percent change tor E, Y, X and P, subtract 1 and multiply by 100. U'-U and RL'-R are differences of percents.

P R O P E R T IE S O F TH E CURRENT
MODEL
To d em o n strate th e p ro p erties o f th e cu rren t
m odel, it w as su b je cte d to th ree different “sh o ck s.” In
ea ch case, th e sh o ck began in 1/1975, an d th e sim u ­
lated re sp o n se w as calcu lated th rou gh IV/1984. T h e
th ree sh o ck s are:1
3
1. F isca l sh o ck . An in crease in cy clically ad ju sted
ex p en d itu res equal to 1 p e rce n t o f GNP.
2. M onetary sh ock . A gradual in crea se in M l over
a y e a r to 3 p e rce n t above th e b ase path.
3. Supply-side sh o ck . A low ering o f th e w orld oil
p rice by 20 p ercen t.
T h e resu lts o f sim ulating th e m o d el w ith e a c h sh o ck
are sh ow n in tables 2-A. T h e se resu lts are su m m arized
in table 5.

13These are the shocks simulated for Professor Klein's model com­
parison seminar, which was reorganized in 1985. For results of the
earlier seminar in the 1970s, see Klein and Burmeister (1976).

22




Fiscal Shock Results
T h e in crea se in cy clically a d ju sted ex p en d itu res
quickly in flu en ces total sp en d in g. T h e total effect,
however, is at m o st a .37 p e rce n t in cre a s e o r a m e a ­
su red elasticity o f .08. T h e fiscal m u ltiplier, AY/AE,
using average values for 1 9 7 8 -7 9 (the m idd le o f the
sam ple period), is .38. T h is is m u ch low er th a n o th e r
eco n o m etric m o d els.1
4
T h e d yn am ics o f the m odel in d ica te that th e initial
in crea se in total sp en d in g is tra n sm itted first an d
tem porarily to real GNP, th e n fully to th e p rice level. In
fact, it ap p ears th at th e p rice level ov ersh oots its final
equilibrium , im plying an u n d e rsh o o tin g o f real GNP.
O utput an d th e p rice level co n tin u e to o scilla te after
40 qu arters, b u t th e fiscal sh o ck h a s essen tially no
effect on ou tp u t in th e long run. C on sequ en tly, th e
effect on th e u n em p lo y m en t rate is sm all, w ith th e
o scillation o f th e u n em p lo y m en t rate sy n ch ro n o u s
w ith output. Sim ilarly, th e effect o n th e lon g -term
in terest rate is negligible even fou r o r five y ea rs after
th e shock, as in tere st ra tes rise w ith in flatio n an d fall
w h en th e rate o f in flation d eclin es.

14See Klein and Burmeister (1976), p. 338.

OCTOBER 1986

FEDERAL RESERVE BANK OF ST. LOUIS

Table 3
The Current Model’s Response to a Monetary Shock
(shocked values denoted by prime)

Quarters
elapsed
1
2
3
4
5
6
7
8
12
16
20
24
28
32
36
40

Exogenous variable
M/M
1.0014
1.0073
1.0188
1.0280
1.0300
1.0300
1.0300
1.0300
1.0300
1.0300
1.0300
1.0300
1.0300
1.0300
1.0300
1.0300

Y'/Y
1.0004
1.0026
1.0081
1.0163
1.0231
1.0265
1.0272
1.0272
1.0272
1.0272
1.0272
1.0272
1.0272
1.0272
1.0272
1.0272

X/X
1.0003
1.0019
1.0084
1.0145
1.0208
1.0226
1.0212
1.0186
1.0087
1.0016
.9948
.9919
.9891
.9904
.9930
.9965

Endogenous variables
P/P
1.0000
1.0001
1.0004
1.0012
1.0026
1.0045
1.0067
1.0090
1.0181
1.0258
1.0319
1.0361
1.0380
1.0370
1.0341
1.0311

U'-U
-.007
-.057
-.262
-.532
-.810
-.961
-.946
-.851
-.421
-.087
.202
.339
.450
.402
.311
.164

RL'-RL
.000
.002
.008
.024
.051
.086
.125
.167
.308
.390
.414
.371
.272
.140
.014
-.076

NOTE: To calculate percent change for M, Y, X and P, subtract 1 and multiply by 100. U'-U and RL'-R are differences of percents.
Monetary Shock Results
A m o n etary sh o ck w orks th rou gh th e m od el in th e
sam e w ay th e fiscal sh o ck d o es — via total sp en d in g.
T h e d ifference is that th e effect is m u ch faster and
larger. Normally, a m o n etary sh o ck is fully reflected in
total sp en d in g after fou r quarter’s (see eq u atio n 1 in
table 1). W ith th e ex p erim en t rep o rted h ere, M l bu ild s
up over a y e a r’s tim e to 3 p e rce n t above th e b ase path.
C on sequen tly, th e full effect on to tal sp en d in g is not
registered until the seventh quarter.
T h e d yn am ics o f th e m od el take over qu ite quickly
w ith re sp ect to o u tp u t an d th e p rice level. O utput
initially rises, bu t after fou r y ears retu rn s clo se to its
b ase path level; it th e n falls below th e b ase level as the
inflation rate co n tin u e s to in crease. In fact, th e e la stic­
ity o f th e p rice level peaks at 1.27 after seven y ears. T h e
4 0-q u arter sim u lation is n o t long en o u gh to d eterm in e
th e n atu re o f the lon g-run equilibriu m .
T h e m o n etary sh o ck p ro d u ces a stron g o scillato ry
m ovem ent in th e u n em p loy m en t rate. Initially, th is
rate drops quickly, falling to alm ost o n e p ercen tag e
poin t below its base p ath after only six qu arters. After
fou r y ears, U m oves back to its base path an d th en
in crea ses above it, staying th ere for th e rem ain d er o f
the sim u lation period.



T h e effect o f th e m o n etary sh o ck o n in terest d e ­
p en d s d irectly on the p rice level resp o n se. Inflation
an d in terest rates resp o n d slow ly to th e sh o ck . As long
as inflation in crea ses, in tere st rates rise above th eir
b ase path. W h en in flation slow s after abou t seven
years, in terest rates m ove b a ck tow ard th e ir b a se p ath .
As w ith several o th e r variables, th e sim u lation period
is n o t lon g en o u gh to d eterm in e th e n atu re o f th e final
equilibrium .

Supply-Side Shock Results
To sim u late th e effect o f a su p p ly shock, th e p rice o f
oil p e r barrel w as a ssu m ed to d rop 20 p ercen t, w h ich
red u ces th e relative p rice o f energy by 8 p e rce n t. T h is
variable d irectly affects th e p rice eq u ation an d in d i­
rectly affects th e p rice level b ec a u se th e d rop in th e
p rice o f oil is a ssu m ed to in sta n ta n e o u sly in crea se
p o ten tial ou tp u t by .4 p e rc e n t.1 By assu m p tio n , total
’
sp en d in g is n ot affected by th e su p p ly sh ock , th at is,
th e relative p rice o f energy is n o t in clu d ed in th e total
sp en d in g eq u atio n . T h is a ssu m p tio n is in d isp ute,
how ever, as T ato m argues th at to tal sp en d in g is te m ­
porarily affected by su ch a sh o ck ."1

l5Rasche and Tatom (June 1977).
16Tatom (1981). His argument rests on the significance of only one of
the lagged values of PE. For this reason, this variation has not been
introduced into the version of the model summarized in table 1.

23

OCTOBER 1986

FEDERAL RESERVE BANK OF ST. LOUIS

Table 4
The Current Model’s Response to a Supply-Side Shock
(shocked values denoted by prime)_________________
Endogenous variables
Exogenous variables
Quarters
P'/P
XF/XF
Y'/Y
X'/X
PE/PE
elapsed
.9998
1.0040
1.0000
1.0000
1
.9200
1.0000
.9999
.9996
1.0040
.9200
2
.9992
1.0040
1.0000
1.0015
.9200
3
1.0000
1.0006
.9988
1.0040
4
.9200
.9984
1.0040
1.0000
1.0019
.9200
5
1.0000
1.0026
.9981
1.0040
.9200
6
.9978
1.0040
1.0000
1.0030
7
.9200
1.0000
1.0031
.9975
1.0040
.9200
8
1.0000
1.0035
.9963
1.0040
.9200
12
1.0000
1.0049
.9953
1.0040
.9200
16
1.0000
1.0048
.9946
1.0040
.9200
20
1.0000
.9944
1.0040
1.0061
24
.9200
1.0000
1.0050
.9946
1.0040
.9200
28
1.0040
1.0000
1.0050
.9948
32
.9200
1.0000
1.0044
.9953
1.0040
.9200
36
.9957
1.0000
1.0046
1.0040
.9200
40

U -U
.109
.172
.130
.132
.110
.071
.049
.040
.030
-.025
-.039
-.093
-.057
—.044
-.018
-.029

RL'-RL
-.003
-.009
-.016
-.023
-.030
-.035
-.040
-.044
-.058
-.064
-.059
-.043
-.022
-.004
.011
.019

NOTE: To calculate percent change for PE, XF, Y, X and P, subtract 1 and multiply by 100. U'-U and RL'-R are differences of percents.

Table 5
Estimated Elasticities for the Current Model
With respect to
With respect to
fiscal shock (E)
monetary shock (M)
Quarters
X
P
Y
elapsed
Y
X
P
1
.06
.05
.00
.29
.21
.00
.06
.00
.36
2
.08
.26
.01
.07
.08
.01
.43
3
.45
.02
.07
.04
.02
4
.58
.52
.04
.04
.08
.05
.91
.62
8
.30
.07
12
.08
.00
.91
.29
.60
.09
.08
-.0 0
.91
.05
16
.86
-.0 4
.10
.91
-.1 7
20
.08
1.06
.11
-.2 7
24
.08
-.0 3
.91
1.20
.12
-.0 5
.91
-.36
1.27
28
.08
-.0 4
.12
.91
-.3 2
32
.08
1.23
-.0 2
.09
.91
1.14
.08
-.2 3
36
.00
.08
.08
.91
-.1 2
1.04
40

T ables 4 and 5 sh o w th at o u tp u t an d p rices resp o n d
qu ite slow ly to th is sh o ck . M oreover, th e m axim u m
effect, w h ich o cc u rs after abou t six y ears, is relatively

24




With respect to
supply shock (PE)
Y
X
.00
-.0 0
.00
.00
.00
-.02
.00
-.01
-.0 4
.00
.00
-.0 4
.00
-.0 6
.00
-.0 6
.00
-.0 8
.00
-.0 6
.00
-.0 6
.00
-.0 6
.00
-.0 6

P
.00
.01
.01
.02
.03
.05
.06
.07
.07
.07
.07
.06
.05

sm all. In fact, th e e la sticities (calcu lated w ith re sp ect
to th e relative p rice o f energy) are sim ilar in m agn itu d e
to th o se for fed eral exp en d itu res.

FEDERAL RESERVE BANK OF ST. LOUIS

OCTOBER 1986

C h a rt 1

Nominal GNP

1970

71

72

73

74

75

76

ASSESSING TH E CURRENT M O D EL’S
PERFORM ANCE
To provide som e in d icatio n o f m od el perfo rm an ce,
th e m od el w as sim u lated ejc post d uring several p eri­
od s after 1969. D enoting su ch sim u lation s as e\ post
m ean s that all sim u lation s w ere w ithin th e sam ple
p eriod and th e exo g en o u s variables took on th e ir
actu al values. All sim u lation s w ere d ynam ic; th at is,
o n ce th e sim u lation w as started, th e m od el g en erated
its ow n lagged values.
T h e se sim ulations are su m m arized in ch arts 1-3
an d table 6. U nfortunately, th e se resu lts m ean little bv
th em selves b ec a u se th ere is n o b asis for co m p ariso n .
R esu lts for sim ilar sim u lation ex e rcises w ith o th e r
m o d els have b ee n p u blish ed for th e 1960s an d early
1970s, bu t are n o t readily available for m o re re cen t



77

78

79

80

81

82

83

1984

period s. C on sequen tly, an y c o n c lu sio n s abo u t th e
m o d el’s p erfo rm an ce are im p ressio n istic.

Total Spending Growth
C harts 1-3 sh ow th e resu lts o f sim u lating Y, X and P
for th e full sim u lation period from 1970 th rou gh 1984.
Sin ce the total sp en d in g eq u atio n co n ta in s no en d o g ­
en o u s variables, th e m od el sim u lation sh o w n in ch art
1 sim ply show s th e fit o f th a t eq u atio n . T h a t fit obvi­
ously d oes qu ite poorly on a q u a rter-to -q u a rter b asis
but seem s to follow th e co n to u rs over several qu arters,
alm ost as if a moving average had b een applied to the
actual observ ations. A d esirab le featu re o f th is eq u a ­
tion is that the q u a rter-to -q u a rter erro rs do n ot ten d to
cu m u late over tim e. T h e erro rs in th e estim ated eq u a­
tion are n o t correlated .
Table 6 show s th at th e RMSE o f Y in cre a se s over

25

OCTOBER 1986

FEDERAL RESERVE BANK OF ST. LOUIS

C h a rt 2

Real GNP

1970

71

72

73

74

75

76

77

tim e and, even w h en stan d ard ized by th e level o f GNP
(SRMSE), it co n tin u es to grow as th e sim u lation period
m oves tow ard th e p resen t. T h is su ggests th at th e
relatio n sh ip b etw een Y an d M h as b eco m e lo o ser
recen tly.

Output Growth
T h e relative degree o f su c c e ss in sim u lating total
sp en d in g is carried over to th e sim u lation o f output.
T h e m od el sim u lated X w ell over th e p eriod s, alth ough
it u n d erestim ated e co n o m ic stren g th d uring th e ex ­
p a n sio n from th e 19 7 3 -7 5 re cessio n . T h e o th e r period
o f su b stan tial d ifferen ce h as o ccu rred sin ce th e third
q u a rter o f 1983. T h e m o d el in d icated a recessio n ,
w h ich did n o t o ccu r.
W h en th e m od el is sim u lated over different period s,
n o c o n siste n t p attern em erg es for th e SRM SE for X. In
th e 1 9 7 0 -8 4 period, th e SRM SE for X ex ceed e d th at for
Y. In th e 19 7 5 -8 4 an d 1 9 7 9 -8 4 periods, how ever, the

26




78

79

80

81

82

83

1984

SRMSE for X w as less th a n for Y, a p p aren tly reflectin g
th e em erging im p o rta n ce o f aggregate d em a n d sh o ck s
relative to su pply-sid e sh o ck s d uring th e se p eriod s.

Inflation
T h e resu lts o f sim ulating th e in flation rate over th e
1 9 7 0 -8 4 period are sh o w n in ch a rt 3. G enerally sp eak ­
ing, th e m ovem ents w ere ap p roxim ated d urin g th e
1 9 7 0 -7 7 period , bu t th e a cc e le ra tio n startin g in th e
seco n d q u arter o f 1978 w as n o t p ick ed up u ntil a y e a r
or so later. T h e e ss e n c e o f th e gen eral d ecelera tio n
from m id-1980 w as cap tu red , b u t sin c e m id-1982, th e
m odel has overestim ated in flation by ab o u t 2 p e rc e n t­
age poin ts.
T h e se visual im p ressio n s are b o rn e ou t in th e c a lc u ­
lation o f RMSE for th e GNP deflator. T h e sh o rtest and
latest p eriod w as b est w ith a stan d ard ized RMSE o f
2.62 p e rce n t. T h e 1 9 7 5 -8 4 perio d w as th e w orst w ith
an SRM SE o f 4.15 p e rce n t. T h e sim u lation for the

FEDERAL RESERVE BANK OF ST. LOUIS

OCTOBER 1986

C h a rt 3

GNP Deflator

1970

71

72

73

74

75

76

77

78

79

80

81

82

83

1984

Table 6
Ex Post Simulation Results

GNP (current dollars)
Real GNP (1982 dollars)
GNP deflator (1982 = 100)
Unemployment rate (percent)
Corporate Aaa bond rate (percent)

1/70-1V/84
RMSE
SRMSE
46.42
2.15%
75.31
2.56
1.99
2.80
1.31
18.91
2.35
23.95

1/75—
IV/84
RMSE
SRMSE
78.24
2.98%
85.55
2.75
3.45
4.15
1.48
19.25
2.89
26.69

I/79-IV/84
RMSE
SRMSE
107.31
3.46%
72.03
2.21
2.62
2.49
1.31
16.60
3.23
26.13

NOTE: RMSE is root mean squared error; SRMSE is standardized RMSE, that is, RMSE divided by the level of the variable and multiplied
by 100.



27

OCTOBER 1986

FEDERAL RESERVE BANK OF ST. LOUIS

overall period w as in betw een , w ith an SRM SE o f 2.79
p ercen t.

Unemployment and Interest Rates
T ab le 6 show s th at th e RMSE for sim u lation s o f the
civilian u n em p loy m en t rate an d th e Aaa b o n d rate do
n o t vary b y m u ch over different sim u lation period s.
T h e RMSE is m o re m eaningfu l for th e se co m p ariso n s
th an SRM SE b e c a u se the RMSE is alread y ex p ressed in
p ercen tag e poin ts.
Sim u lation s o f th e m ovem ents o f th e Aaa bo n d rate
w ere g enerally u nim pressive. A lthough th e RMSE w as
little different for th e alternative sim u lation period s, it
in crea sed as th e sim u lation w as brou ght c lo se r to the
p resen t.

SUMMARY

p rice level, w ith very little effect on o u tp u t an d u n e m ­
ploym ent. F iscal a ctio n s have sm all sh o rt-ru n effects
th at d isap p ear (in term s o f output) qu ite quickly.
W hile th e su pply-sid e effects are n ot stron g acco rd in g
to co n v en tion al ela sticities, th e se effects can b e im p o r­
tan t if energy p rices m ove d ram atically.
T h e p erfo rm an ce o f th e m o d el is difficult to gauge,
but, for th e m o st part, th e sim u lation re su lts w ere
d eem ed su cce ssfu l.
post sim u latio n s are th e c o n ­
ven tion al m eth o d o f a sse ssin g a m o d e l’s p erfo rm an ce,
b u t th ey are m o re m eaningfu l w h en co m p a red w ith
th o se from o th e r m o d els. T h e re have b e e n n o p u b ­
lish ed stu d ies o f h o w o th e r m o d els are p erform ing in
th e 1980s. A m o re a ccu ra te evaluation aw aits co m p a ri­
son w ith sim ilar resu lts from o th e r cu rren t m od els.

R EFER EN C E S

Sin ce 1970, th e g en eral form o f th e m od el h as b een
m ain tain ed , bu t several ch an g es in its sp ecificatio n
an d estim atio n have b een m ade. O ne n o table ch an g e
h as b een sim p lification — using rates o f ch an g e in ­
stead o f first d ifferences. A n o th er is th e ad d itio n o f
su p p ly -sid e variables — th e relative p rices o f energy
an d p rice co n tro l an d d eco n tro l d u m m ies and , m ost
recen tly, a d um m y in th e GNP eq u atio n to cap tu re the
shift in th e relatio n sh ip sin ce 1981. O th er ch an g es
in clu d ed alternative estim ates o f p o ten tial o u tp u t an d
fed eral ex p en d itu res, an d a d ju stm en ts for a u to co rre ­
latio n in several o f th e eq u atio n s.

Andersen, Leonall C., and Keith M. Carlson. “A Monetarist Model
for Economic Stabilization,” this Review (April 1970), pp. 7-25.
Andersen, Leonall C., and Jerry L. Jordan. “Monetary and Fiscal
Actions: A Test of Their Relative Importance in Economic Stabili­
zation,” this Review (November 1968), pp. 11-24.
Carlson, Keith M. “Does the St. Louis Equation Now Believe in
Fiscal Policy?” this Review (February 1978), pp. 13-19.
Considine, William. “Public Policy and the Current Inflation,” pre­
pared as part of a summer intern program at the U.S. Treasury
Department (September 5, 1969).
de Leeuw, Frank, and Edward Gramlich. “The Channels of Mone­
tary Policy,” Federal Reserve Bulletin (June 1969), pp. 472-91.
_________“The Federal Reserve-MIT Econometric Model,” Fed­
eral Reserve Bulletin (January 1968), pp. 11-46.
de Leeuw, Frank, and Thomas M. Holloway. “Cyclical Adjustment
of the Federal Budget and Federal Debt,” Survey of Current Busi­
ness (December 1983), pp. 25-40.
Klein, Lawrence R., and Edwin Burmeister, eds. Econometric Model
Performance (University of Pennsylvania Press, 1976).
Okun, Arthur M. “ Potential GNP: Its Measurement and Signifi­
cance,” 1962 Proceedings of the Business and Economic Statistics
Section of the American Statistical Association, pp. 98-104.
Rasche, Robert H., and John A. Tatom. "Energy Resources and
Potential GNP,” this Review (June 1977a), pp. 10-24.
_________“The Effects of the New Energy Regime on Economic
Capacity, Production, and Prices,” this Review (May 1977b), pp.

D esp ite th e se ch an g es, th e p ro p erties o f th e m odel
rem ain essen tially u n ch an g ed . M o n etaiy a ctio n s have
a large sh o rt-ru n effect on to tal sp end ing, o u tp u t and
u n em p lo y m en t; over th e long run, how ever, th e effect
on total sp en d in g is alm ost en tirely reflected in th e

Tatom, John A. “Energy Prices and Short-Run Economic Perfor­
mance,” this Review (January 1981), pp. 3-17.
Yohe, William P., and Denis S. Karnosky. “Interest Rates and Price
Level Changes, 1952-69,” this Review (December 1969), pp. 1838.

T h e St. Louis m odel, as originally p u b lish ed in April
1970, w as d esigned to fo cu s on th e im p o rtan ce o f
m o n etary a ctio n s in th e d eterm in atio n o f spending,
ou tp u t an d p rice s. Its stru ctu re differed su bstan tially
from o th e r ec o n o m e tric m od els at th at tim e. It c o n ­
sisted o f th e A n d ersen -Jo rd an GNP eq u atio n and sev­
eral o th e r em p irical relatio n sh ip s; it w as recu rsive in
form . It estim ated GNP d irectly using m o n eta iy and
fiscal variables, in sh arp co n tra st to th e con vention al
a p p ro ach o f estim atin g th e co m p o n e n ts o f GNP and
th e n su m m in g th e m to obtain a GNP estim ate.

28




2 12
-

.

The follow ing article is reprinted fr o m the N ovem b er
1968 Federal Reserve Bank o f St. Louis Review.

M onetary and Fiscal Actions: A
Test of Their Relative Im portance
in Econom ic Stabilization
Leonall C. Andersen and Jerry L. Jordan

H

IGH em ploym ent, rising ou tp u t o f good s and
services, an d relatively stable p rices are th ree w idely
a cc e p te d nation al ec o n o m ic goals. R esponsib ility for
ec o n o m ic stabilization actio n s to m eet th ese goals has
b een assigned to m o n etaiy an d fiscal au th o rities. T h e
F ed eral Reserve System h as th e m a jo r resp onsib ility
for m o n etary m an ag em ent. F iscal a ctio n s involve fed ­
eral governm ent sp en d in g plans and taxing provi­
sion s. G overnm ental u nits involved in fiscal actio n s
are th e C on gress an d th e A d m inistration, in clu d in g
th e Treasury, th e B ureau o f th e Budget, and th e C o u n ­
cil o f E co n o m ic Advisers.
T h is article rep o rts th e resu lts o f re cen t re sea rch
w h ich te ste d th ree co m m o n ly h eld p ro p o sition s c o n ­
cern in g th e relative im p o rtan ce o f m o n eta iy and fiscal
a ctio n s in im p lem en tin g ec o n o m ic stabilization p o l­
icy. T h e se p ro p o sitio n s are: th e re sp o n se o f e co n o m ic
activity to fiscal actio n s relative to th at o f m o n eta iy
a ctio n s is (1) greater, (2) m ore p red ictable, an d (3)
faster. Sp ecific m eanings, for th e p u rp o ses o f this
article, o f th e broad term s u sed in th e se p ro p o sition s
are p resen ted later.

The authors give special thanks for helpful comments on earlier drafts
to: Robert Basmann, Karl Brunner, James Buchanan, Albert Burger,
Keith Carlson, David Fand, Milton Friedman, Gary Fromm, Michael
Levy, Thomas Mayer, A. James Meigs, David Meiselman, Allan Meltzer, Richard Puckett, David Rowan, James Tobin, Robert Weintraub,
and William Yohe. The authors are, of course, solely responsible for the
analyses and results presented in this article.



T h is article d o es n o t attem p t to te st rival e co n o m ic
th eo ries o f th e m e ch a n ism by w h ich m o n etary and
fiscal a ctio n s in flu en ce ec o n o m ic activity. N eith er is it
in ten d ed to develop evid en ce bearin g d irectly on any
cau sal relatio n sh ip s im plied by su ch th eo ries. M ore
elaborate p ro ced u res th an th o se u sed h ere w ould be
required in o rd er to test any th eo ries u nd erlying the
fam iliar sta tem en ts regarding resu lts ex p ected from
m on etary an d fiscal a ctio n s. However, em p irical rela­
tio n sh ip s are developed b etw een frequ en tly u sed
m easu res o f stabilization a ctio n s an d e co n o m ic activ­
ity. T h ese relatio n sh ip s are co n siste n t w ith th e im p li­
ca tio n s o f som e th e o rie s o f stab ilization policy an d are
in co n sisten t w ith other's, as w ill b e p o in ted out.
A b rief d iscu ssio n o f th e forces in flu en cin g e c o ­
n o m ic activity is p re sen ted first. Next, w ith th is th eory
as a background , sp ecific m e a su res o f e c o n o m ic activ­
ity, fiscal actio n s, and m o n eta iy a ctio n s are selected .
T h e resu lts o f testin g th e th ree p ro p o sitio n s n oted
above, to g eth er w ith o th e r sta tem e n ts co n c e rn in g th e
resp o n se o f eco n o m ic activity to m o n etary an d fiscal
forces, are th en p resen ted . Finally, so m e im p licatio n s
for the co n d u ct o f stab ilization policy are draw n from
th e resu lts o f th e se tests.

A T H E O R E T IC A L V IE W O F E C O N O M IC
A C T IV IT Y
O ur eco n o m ic system co n sists o f m any m arkets.
Every com m od ity, service an d fin an cial a sse t is
view ed as co n stitu tin g an individual m arket in w h ich a
29

OCTOBER 1986

FEDERAL RESERVE BANK OF ST. LOUIS

p articu lar item is trad ed an d a p rice is d eterm in ed . All
of th e se m arkets are linked to g eth er in varying d e­
grees, sin ce p rices in o n e m arket in flu en ce d ecisio n s
m ad e in o th e r m arkets.
About a ce n tu ry ago, Leon W alras o u tlin ed a fram e­
w ork for analyzing a co m p lex m arket eco n o m y . Su ch
an analysis in clu d es a d em an d an d a su pply relatio n ­
sh ip for eveiy co m m o d ity an d for e a c h fa cto r o f p ro ­
d u ctio n . T rad in g in th e m arkets resu lts in p rices being
esta b lish ed w h ich cle a r all m arkets, i.e., th e am ou n t
offered in a m arket eq u als th e am o u n t taken from the
m arket. A ccord ing to th is analysis, o u tsid e o c c u r­
re n ce s reflected in shifts in d em an d an d su p p ly rela­
tio n sh ip s ca u se ch an g es in m arket p rices and in q u a n ­
tities traded . T h e se o u tsid e events in clu d e ch an g es in
p re fe ren ces o f m arket p articip an ts, in re so u rce e n ­
d ow m en ts, an d in tech nolog y. F in an cial asse ts w ere
n o t view ed as providing utility o r satisfactio n to th e ir
h o ld ers an d w ere th e re fo re e x c lu d e d from th e
analysis.
L a ter d ev e lo p m e n ts in e c o n o m ic th e o ry have
view ed fin an cial asse ts as providing flow s o f services
w h ich also provide utility o r satisfactio n to hold ers.
F or exam ple, a h o ld e r o f a co m m ercial bank tim e
d ep o sit receives liquidity service (ease o f co n versio n
into th e m edium o f exch ange), store o f value service
(ability to m ake a future p u rch ase), risk avoid ance
service (little risk o f loss), an d a fin an cial yield . A cco rd ­
ing to th is la te r view, e c o n o m ic en tities in co rp o ra te
ch o ice s am on g goods, seiv ices, and fin ancial assets
into th e ir d ecisio n -m ak in g p ro cesses.

Exhibit 1
Classification of Market Variables

Dependent Variables
Prices and quantities of goods and services.
Prices and quantities of factors of production.
Prices (interest rates) and quantities of financial assets.
Expectations based on:
a. movements in dependent variables.
b. expected results of random events.
c. expected changes in fiscal and monetary policy.
Independent Variables
Slowly changing factors:
a. preferences.
b. technology.
c. resources.
d. institutional and legal framework.
Events outside the domestic economy:
a. change in total world trade.
b. movements in foreign prices and interest rates.
Random events:
a. outbreak of war.
b. major strikes.
c. weather.
Forces subject to control by:
a. fiscal actions.
b. monetary actions.

in flu en ce ex p o rts an d th erefo re are largely an o u tsid e
in flu en ce on d o m estic m arkets.

T h e fact th a t e c o n o m ic en tities m ake c h o ic e s in
b o th m arkets for g oo d s and seiv ices an d m arkets for
fin an cial asse ts req u ires th e ad d ition o f d em an d an d
su pply relatio n sh ip s for eveiy fin an cial asset. M arket
in terest rates (prices o f fin an cial assets) an d ch an g es
in th e stocks o u tstan d in g o f m o st fin an cial asse ts are
d eterm in ed by th e m arket p ro cess along w ith p rices
an d qu an tities o f good s an d seiv ices.

M arket ex p e cta tio n s have also b ee n a ssign ed a
significant fa cto r in m arkets, bu t th e se are not view ed
as a d istin ctly in d e p en d e n t force. E x p ecta tio n s result
from m arket p a rticip a n ts b asin g th e ir d ecisio n s on
m ovem en ts in m ark et-d eterm in ed variables, o r they
are derived from m arket re sp o n ses to th e ex p ected
resu lts o f ran d o m events, su ch as th e o u tb reak o f a w ar
o r th e a n ticip a tio n o f ch a n g es in fiscal o r m o n eta iy
policy.

T h e se th e o retical d evelop m ents have enlarged the
n u m b er o f in d e p en d e n t fo rces w h ich are regarded as
in flu en cin g m ark et-d eterm in ed p rices, in terest rates,
qu an tities p ro d u ced o f co m m o d ities and stocks o u t­
stan d in g o f fin an cial a ssets. G overnm ent an d m o n e ­
tary au th o rities are view ed as exertin g in d ep en d en t
in flu en ces in th e m arket system . T h e se in flu en ces are
called fiscal and m o n etary p o licies or actio n s. R an­
dom events, su ch as th e ou tbreak o f w ar, strikes in key
in d u stries an d prolon ged drought, exert o th e r m arket
in flu en ces. Growth in w orld trade an d ch an g es in
foreign p rices an d in tere st rates, relative to o u r own,

T h e se d ep en d en t an d in d e p en d e n t m arket vari­
ables are su m m arized in exhibit 1. T h e d ep en d en t
variables are d eteim in e d by the in terp lay o f m arket
forces w h ich resu lts from ch a n g es in th e in d e p en d e n t
variables. M arket-d eterm in ed variables in clu d e p rices
and qu an tities o f goo d s an d seiv ices, p rices a n d q u an ­
tities o f factors o f p ro d u ctio n , p rices (interest rates I
and qu an tities o f financial a ssets, an d ex p ecta tio n s,
in d e p en d e n t variables co n sist o f slow ly ch an g in g fac­
tors, forces from o u tsid e o u r eco n om y, rand om
events an d fo rces su b je ct to co n tro l by fiscal an d
m o n etary au th o rities. A ch a n g e in an in d ep en d en t

30




FEDERAL RESERVE BANK OF ST. LOUIS

variable (for exam ple, a fiscal o r a m o n eta iy action)
ca u ses ch an g es in m any o f th e m ark et-d eterm in ed
(dependent) variables.

MEASURES O F ECONOMIC ACTIVITY
AND O F MONETARY AND FISCAL
ACTIONS
T h re e th eo retical ap p ro ach es have b een advanced
by eco n o m ists for analyzing th e in flu en ce o f m o n eta iy
an d fiscal a ctio n s on e c o n o m ic activity. T h e se a p ­
p ro a ch es are th e textbook K eynesian analysis derived
from e co n o m ic thou ght o f th e late 1930s to th e early
1950s, th e portfolio ap p ro ach d eveloped over th e last
tw o d ecad es, and th e m o d ern qu an tity th e o iy of
m oney. E ach o f th e se th eo ries h as led to p o p u la r and
fam iliar statem en ts regarding th e d irectio n , am oun t,
an d tim ing o f fiscal and m o n eta iy in flu en ces on e c o ­
n o m ic activity. As n o ted earlier, th ese th eo ries and
th e ir linkages will not be tested directly, bu t th e valid­
ity o f som e o f th e statem en ts w h ich p u rport to re p re­
sen t th e im p licatio n s o f th e se th eo ries will be ex a m ­
in ed . F o r th is p u rpose, frequ ently u sed m easu res of
e c o n o m ic activity, m o n e ta ry a c tio n s, an d fiscal
a ctio n s are selected .

Economic Activity
T otal sp end ing for goods and send ees (gross n a ­
tional p ro d u ct at cu rren t prices) is u sed in th is article
as th e m easu re o f e co n o m ic activity. It c o n sists o f total
sp en d in g on final goods and services by h o u seh old s,
b u sin esses and governm ents plus n et foreign invest­
m ent. Real ou tp u t o f goods and services is lim ited by
re so u rce end ow m en ts an d techn ology, w ith th e a c ­
tual level o f output, w ithin th is co n strain t, d eterm in ed
by th e level o f total sp en d in g and o th e r factors.

Monetary Actions
M onetary actio n s involve prim arily d ecisio n s o f the
T re a su iy and th e Fed eral Reserve System . Treasu ry
m o n eta iy actio n s co n sist o f variations in its ca sh h o ld ­
ings, d ep osits at Federal R eseive banks and at co m ­
m ercial banks, and issu a n ce of T re a su iy cu rren cy .
Fed eral R eseive m o n eta iy a ctio n s in clu d e ch an g es in
its portfolio o f G overnm ent secu rities, variations in
m em b er bank reserve requ irem en ts, and ch an g es in
th e Fed eral Reserve d isco u n t rate. Banks and th e p u b­
lic also engage in a form o f m o n etaiy actio n s. C om ­
m ercial bank d ecisio n s to hold e x cess reseives co n s ti­
tu te a m o n eta iy actio n . Also, b ec a u se o f differential
reserve requ irem ents, th e p u b lic’s d ecisio n s to hold
varying am o u n ts o f tim e d ep o sits at co m m ercial banks



OCTOBER 1986

or cu rre n cy relative to d em an d d ep o sits are a form of
m o n etary actio n , bu t are n o t view ed as stabilization
a ctio n s. However, th ey are taken in to co n sid era tio n by
stabilization a u th o rities in form ing th e ir ow n a ctio n s.
Exhibit 2 su m m arizes th e various so u rces o f m o n eta iy
actio n s related to e co n o m ic stabilization .
T h e m o n eta iy b a s e 1 is co n sid ere d by b o th th e p o rt­
folio an d th e m o d ern qu an tity th e o iy sch o o ls to lie a
strategic m o n eta iy variable. T h e m o n eta iy b a se is u n ­
d er d irect co n tro l o f the; m o n eta iy au th o rities, w ith
m a jo r co n tro l ex erted by th e F ed eral R eseive System .
Both o f th e se sch o o ls c o n sid e r an in crea se in the
m o n eta iy base, o th e r fo rces co n sta n t, to b e an exp an sio n aiy in flu en ce on e c o n o m ic activity an d a d ecrea se
to b e a restrictive in flu en ce.
T h e portfolio sch o o l h o ld s th at a ch a n g e in th e
m o n eta iy b a se affects in v estm en t sp en d in g, an d
th ereb y aggregate spen din g, th rou gh ch a n g es in m ar­
ket in terest rates relative to th e su p p ly p rice o f cap ital
(real rate o f retu rn on capital). T h e m o d ern qu antity
th e o iy h old s th at th e in flu en ce o f th e m o n eta iy b ase
w orks through ch a n g es in th e m o n ey stock w h ich in
turn affect p rices, in terest rates an d sp en d in g on
good s an d seiv ices. In c re a se s in th e b a se are reflected
in in crea ses in th e m o n ey sto ck w h ich in tu rn result
directly an d in d irectly in in crea sed ex p en d itu res on a
w h ole sp ectru m o f cap ital an d c o n su m e r g ood s. Both
p rices o f good s an d in terest ra tes form th e tra n sm is­
sion m e ch a n ism in th e m o d ern qu an tity th eo iy .
T h e m o n ey sto ck is also u sed as a strategic m o n e­
taiy variable in e a c h o f th e a p p ro a ch es to stabilization
policies, as th e above d iscu ssio n h as im plied . T h e
sim p le K eynesian a p p ro a ch p o stu lates th at a ch an g e
in th e stock o f m on ey relative to its d em an d resu lts in
a ch a n g e in in terest rates. It also p o stu lates th at in ­
vestm en t sp en d in g d ecisio n s d ep en d on in terest
rates, an d th at grow th in aggregate sp en d in g d ep en d s
in tu rn on th e se in v estm en t d ecisio n s. Sim ilarly, in th e
portfolio sch o o l o f th ou gh t, ch a n g es in th e m on ey
stock lead to ch a n g es in in terest rates, w h ich are
follow ed by su b stitu tio n s in asset portfolios; th en

'The monetary base is derived from a consolidated monetary bal­
ance sheet of the Federal Reserve and the Treasury. See Leonall C.
Andersen and Jerry L. Jordan, “The Monetary Base: Explanation
and Analytical Use,” in the August 1968 issue of this Review. Since
the uses of the base are bank reserves plus currency held by the
public, it is often called “demand debt of the Government.” See
James Tobin, “An Essay on Principles of Debt Management," in
Fiscal and Debt Management Policies, The Commission on Money
and Credit, Prentice-Hall, Inc., Englewood Cliffs, N.J., 1963. In
some analyses, Tobin includes short-term government debt out­
standing in the monetary base.

31

FEDERAL RESERVE BANK OF ST. LOUIS

OCTOBER 1986

Exhibit 2
Stabilization Actions and Their Measurement

Stabilization actions
1. Monetary Actions
Federal Reserve System
a. open market transactions.
b. discount rate changes.
c. reserve requirement changes.
Treasury
a. changes in cash holdings.
b. changes in deposits at Reserve banks.
c. changes in deposits at commercial banks.
d. changes in Treasury currency outstanding.
2. Fiscal Actions
Government spending programs.
Government taxing provisions.

Frequently used measurements of actions
1. Monetary Actions
Monetary base.'
Money stock, narrowly defined.1
Money plus time deposits.
Commercial bank credit.
Private demand deposits.
2. Fiscal Actions
High-employment expenditures.’
High-employment receipts.1
High-employment surplus.1
Weighted high-employment expenditures.
Weighted high-employment receipts.
Weighted high-employment surplus.
National income account expenditures.
National income account receipts.
Autonomous changes in government tax
rates.
Net government debt outside of agencies
and trust funds.

’Tests based on these measures are reported in this article. The remaining measures were used in
additional tests. These results are available on request.
finally, total sp en d in g is affected. In terest rates, a c ­
co rd in g to th is la tte r sch o o l, are the key part o f th e
tra n sm issio n m ech an ism , in flu en cin g d ecisio n s to
h old m o n ey versus alternative fin an cial asse ts as well
as d ecisio n s to invest in real a sse ts. T h e in flu en ce of
ch a n g es in th e m o n ey sto ck on e c o n o m ic activity,
w ithin th e m o d ern q u an tity th e o iy fram ew ork, h as
alread y b ee n d iscu sse d in th e previous p aragraph.1
T h e m o n eta iy base, as noted, plays an im p ortan t
role in b o th the portfolio and th e m o d ern quantity
th e o iy ap p ro ach es to m o n eta iy th eo iy . However,
th ere rem ain s co n sid erab le co n tro versy regarding th e
role o f m o n ey in d eterm in in g e c o n o m ic activity, ran g­
ing from “m on ey d o es n ot m a tter” to “m o n ey is the
d o m in an t facto r.” In re ce n t y ears th ere h as b een a
g en eral a c c e p ta n c e that m oney, am ong m any o th er
in flu en ces, is im p ortan t. T h o m as M ayer, in a re cen t
book, su m m arizes th is controversy. He co n clu d e s:

2Also see Leonall C. Andersen and Jerry L. Jordan, “Money in a
Modern Quantity Theory Framework” in the December 1967 issue
of this Review. For an excellent analysis of these three monetary
views see David I. Fand, “Keynesian Monetary Theories, Stabiliza­
tion Policy and the Recent Inflation,” a paper presented to the
Conference of University Professors, Ditchiey Park, Oxfordshire,
England, Sept. 13, 1968.

32




All in all, m u c h r e c e n t e v id e n c e s u p p o rts th e view th at
th e sto ck o f m o n ey an d , th e re fo re , m o n e ta iy p o licy,
h a s a su b sta n tia l e ffe ct. N ote, how ever, th a t th is re a d ­
ing o f th e e v id e n ce is by n o m e a n s a c c e p ta b le to all
e c o n o m ists . S o m e , p ro fe s so r F rie d m a n a n d Dr. W arb u rto n for exam p le, arg u e th at c h a n g e s in th e s to c k o f
m o n ey d o have a d o m in a n t e ffe ct o n in c o m e , at le a st in
th e lo n g ru n , w h ile o th e rs s u c h as P ro fe ss o r H ansen
believe th a t c h a n g e s in th e s to c k o f m o n e y a re largely
offset by o p p o site c h a n g e s in v e lo c ity .1

T h e th eo ries aside, ch a n g es in th e m o n eta iy base
an d ch a n g es in th e m on ey sto ck are frequ en tly u sed as
m easu res o f m o n eta iy a ctio n s. T h is article, in part,
tests th e u se o f th e se variables for th is p u rp o se. M oney
is narrow ly defined as th e n o n b an k p u b lic’s h old ings
of d em an d d ep o sits p lu s cu rre n cy . C h an g es in th e
m on ey stock m ainly reflect m ov em en ts in th e m o n e­
taiy b ase; how ever, th ey also reflect d ecisio n s o f c o m ­
m ercial banks to hold e x c e ss reserves, o f th e n o n b an k
p u blic to h o ld cu rre n cy an d tim e d ep o sits, an d o f the
T re a su iy to hold d em an d d ep o sits at co m m ercia l
banks. T h e m o n eta iy b a se reflects m o n e ta iy a ctio n s o f

3Thomas Mayer, Monetary Policy in the United States, Random
House, NY, 1968, pp. 148-49.

FEDERAL RESERVE BANK OF ST. LOUIS

th e F ed eral Reserve, an d to a le sse r extent, th o se o f th e
Treasu ry an d gold flows. But ch an g es in th e b ase have
b een found to be d o m in ated by a ctio n s o f the Federal
Reserve.4
O th er aggregate m easu res, su ch as m o n ey plus tim e
d ep o sits, bank cred it and private d em an d d eposits,
are frequ ently u sed as m o n eta iy in d icato rs (exhibit 2).
T ests using th e se in d icato rs w ere also m ad e. T h e
resu lts o f th e se tests did n o t ch an g e th e co n clu sio n s
rea ch ed in this article; th e se resu lts are available on
requ est. M arket in terest rates are n ot u sed in th is
article as strategic m o n eta iy variables sin c e they
reflect, to a great extent, fiscal actio n s, ex p ectation s,
an d o th e r factors w h ich ca n n o t p roperly be called
m o n eta iy actio n s.

Fiscal Actions
T h e in flu en ce o f fiscal actio n s on ec o n o m ic activity
is frequently m easu red by federal governm ent sp e n d ­
ing, ch an g es in federal tax rates, o r federal budget
d eficits and su rp lu ses. T h e textbook K eynesian view
has b een reflected in m any p o p u lar d iscu ssio n s of
fiscal in flu en ce. T h e portfolio ap p ro ach an d th e m o d ­
e m qu antity theory suggest alternative analy ses o f
fiscal influ en ce.
T h e elem en tary textbook K eyn esian view c o n c e n ­
trates alm ost exclusively on th e d irect in flu en ce o f
fiscal actio n s on total spendin g. G overnm ent sp en d in g
is a d irect dem and for good s and services. Tax rates
affect d isp osable in co m e, a m a jo r d eterm in an t o f c o n ­
su m er spending, an d profits o f b u sin esses, a m ajo r
d eterm in an t o f investm ent spendin g. Budget su r­
pluses and deficits are u sed as a m easu re o f th e net
d irect in flu en ce o f sp end ing an d taxing on e co n o m ic
activity. M ore advanced textbooks also in clu d e an
in d irect in flu en ce o f fiscal actio n s on e c o n o m ic activ­
ity through ch an g es in m arket in terest rates. In eith e r
case, little co n sid eratio n is gen erally given to th e
m eth o d o f finan cing exp en d itu res.
T h e portfolio ap p ro ach as d eveloped by T o b in a t­
trib u tes to fiscal a ctio n s b o th a d irect in flu en ce on
e co n o m ic activity an d an in d irect in flu en ce. B oth in ­
flu en ces take into co n sid eratio n th e fin an cin g o f gov­
ern m en t expenditures/' F in an cin g o f ex p en d itu res by
issu a n ce o f d em and d ebt o f m o n eta iy au th o rities (the
m on etary base) resu lts in th e full K eynesian m u ltip lier

“For a discussion of these points, see: Karl Brunner, “The Role of
Money and Monetary Policy,” in the July 1968 issue of this Review.
5Tobin, pp. 143-213.



OCTOBER 1986

effect. F in an cin g by e ith e r taxes o r b orrow ing from the
p u blic h as a sm aller m u ltip lier effect o n spen din g.
T o b in views th is d irect in flu en ce as tem porary.
T h e in d irect in flu en ce o f fiscal actio n s, a cco rd in g to
Tobin, resu lts from th e m a n n er o f fin an cin g th e gov­
ern m en t debt, th at is, variations in th e relative
a m o u n ts o f d em an d debt, sh o rt-term debt, an d lon g­
term debt. F or exam ple, an ex p a n sio n a iy m ove w ould
be a shift from lon g-term to sh o rt-term d eb t o r a shift
from sh o rt-term to d em an d d ebt. A restrictiv e a ctio n
w ould resu lt from a shift in th e o p p o site d irectio n . As
in th e ca se o f m o n etary actio n s, m arket in tere st rates
o n fin an cial a ssets an d th e ir in flu en ce o n in vestm en t
spen din g m ake up th e tra n sm issio n m ech a n ism .
T h e m o d ern qu an tity th eory also su ggests th at th e
in flu en ce o f fiscal a ctio n s d ep en d s o n th e m eth o d o f
financing governm ent ex p en d itu res. T h is ap p roach
m aintain s th at fin an cin g ex p en d itu res by e ith e r taxing
o r borrow ing from th e p u b lic involves a tran sfer o f
co m m an d over re so u rces from th e p u b lic to th e gov­
ern m en t. However, th e n et in flu en ce on total s p e n d ­
ing resu ltin g from in terest rate an d w ealth ch a n g es is
am biguous. O nly a d eficit fin an ced by th e m o n eta iy
system is n ecessa rily ex p an sio n aiy .'1
H igh-em ploym ent budget co n c e p ts have b een d e­
veloped as m easu res o f th e in flu en ce o f fiscal a ctio n s
on ec o n o m ic activity.7 In th e se bu d g et co n c e p ts, e x ­
p en d itu res in clu d e b o th th o se for good s an d seiv ices
an d th o se for tran sfer paym ents, a d ju sted lo r th e
in flu en ce o f e c o n o m ic activity. R eceip ts, sim ilarly a d ­
ju sted , prim arily reflect legislated ch a n g es in federal
governm ent tax rates, in clu d in g Social Secu rity taxes.

6The importance of not overlooking the financial aspects of fiscal
policy is emphasized by Carl F. Christ in “A Simple Macroeconomic
Model with a Government Budget Restraint,” Journal of Political
Economy, Vol. 76, No. 1, January/February 1968, pp. 53-67. Christ
summarizes (pages 53 and 54) that “the multiplier effect of a change
in government purchases cannot be defined until it is decided how to
finance the purchases, and the value of the multiplier given by the
generally accepted analysis [which ignores the government budget
restraint] is in general incorrect... (the) multiplier effect of govern­
ment purchases may be greater or less than the value obtained by
ignoring the budget restraint, depending on whether the method of
financing is mainly by printing money or mainly by taxation.”
7See Keith M. Carlson, “Estimates of the High-Employment Budget:
1947-1967,” in the June 1967 issue of this Review. The highemployment budget concept was used in the Annual Report of the
Council of Economic Advisers from 1962 to 1966. For a recent
analysis using the high-employment budget, see "Federal Fiscal
Policy in the 1960s,” Federal Reserve Bulletin, September 1968, pp.
701-18. According to this article, “the concept does provide a more
meaningful measure of the Federal budgetary impact than the
published measures of actual Federal surplus or deficit taken by
themselves.”

33

FEDERAL RESERVE BANK OF ST. LOUIS

T h e net o f re ceip ts and ex p en d itu res is u sed as a n et
m easu re o f ch an g es in ex p en d itu re provisions and in
tax rates. T h e se h ig h -em p loy m ent co n c e p ts are u sed
in th is article as m e a su res o f fiscal a ctio n s (exhibit 2).
T e sts w ere also m ad e alternatively u sing natio n al in ­
co m e a cc o u n t governm ent ex p en d itu res an d re­
ceip ts, a series m easu rin g au to n o m o u s ch an g es in
governm ent tax rates, a w eigh ted h ig h -em p loy m ent
ex p en d itu re an d receip t series, an d a series o f U. S.
g overnm ent d ebt h eld by the p u b lic plus Fed eral
Reserve h old ings o f U. S. governm ent secu rities. T h ese
tests did not ch a n g e th e c o n c lu sio n s re a ch ed in this
article. R esu lts o f th e se tests are available o n req u est.

Other Influences
M easu res o f o th e r in d e p en d e n t fo rces w h ich in ­
flu en ce e c o n o m ic activity are n o t u sed in th is article.
Yet th is sh o u ld n o t b e co n stru e d to im ply th at th e se
fo rces are not im p ortant. It is a cc e p te d by all e c o n o ­
m ists th at th e n o n -m o n e ta iy an d n o n -fiscal forces
listed in exh ibit 1 have an im p o rtan t in flu en ce on
e c o n o m ic activity. However, reco g n itio n o f th e e x ist­
e n c e o f th ese “o th e r fo rce s” d o es not p reclu d e the
testin g o f p ro p o sitio n s relating to th e relative im p or­
ta n c e o f m o n eta iy an d fiscal forces. T h e analysis p re­
sen ted in th is stud y provides in d irect evid en ce b e a r­
ing o n th e se “o th e r fo rces.” T h e in tere ste d re ad e r is
en co u rag ed to read th e te ch n ica l n o te p resen ted in
th e ap p en d ix to this article before p roceed in g.

TESTING TH E PRO PO SITIO N S
T h is sectio n rep o rts th e resu lts o f testin g th e th ree
p ro p o sitio n s u n d e r co n sid eratio n . First, th e co n c e p t
o f testin g a h y p o th esis is briefly d iscu ssed . Next, th e
resu lts o f reg ressio n analy ses w h ich relate th e m e a ­
su res o f fiscal an d m o n etaiy a ctio n s to total sp en d in g
are rep o rted . Finally, statistics d eveloped from the
reg ressio n analy ses are u sed to test th e sp ecific
p ro p o sition s.

The Concept o f Testing a Hypothesis
In scien tific m ethod ology, testin g a h y p o th esis c o n ­
sists o f th e sta tem e n t o f th e h yp oth esis, deriving by
m ean s o f logic te stab le co n se q u e n ce s e x p e cte d from
it, an d th e n taking o bserv ations from past ex p e rie n ce
w h ich sh o w th e p re se n c e or a b se n c e o f th e ex p ected
co n se q u e n ce s. If th e ex p e cted co n se q u e n ce s do n ot
o ccu r, th e n th e h y p o th esis is said to be “n o t c o n ­
firm ed ” by th e evid en ce. If, on th e o th e r han d , the
e x p e cted co n se q u e n ce s o ccu r, th e h y p o th esis is said
to b e “co n firm ed .”

34




OCTOBER 1986

It is im p o rtan t to keep the follow ing poin t in m ind.
In scien tific testing, a h yp o th esis (or co n je c tu re ) m ay
b e fou n d “n o t co n firm ed ” an d th erefo re refu ted as the
ex p lan ation o f th e relatio n sh ip u n d e r ex am in ation .
However, if it is fou n d to be “co n firm ed ,” th e h y p o th e­
sis ca n n o t be said to have b een proven true. In the
latter case, how ever, th e h yp o th esis rem ain s an a c ­
cep tab le pro p o sition o f a real w orld relatio n sh ip as
long as it is fou nd to b e “co n firm ed ” in future tests."
T h e results p resen ted in th is stud y all b e a r on w hat
is co m m o n ly called a “red u ced form ” in ec o n o m ics. A
red u ced -form eq u atio n is a derivable co n s e q u e n ce o f
a system o f eq u atio n s w h ich m ay b e h y p o th esiz ed to
rep resen t th e stru ctu re o f th e eco n o m y (i.e., a socalled stru ctu ral m odel). In o th e r w ords, all o f th e
factors an d cau sal relatio n s w h ich d eterm in e total
sp en d in g (GNP) are “su m m a riz e d ” in o n e eq u ation .
T h is red u ced -fo rm eq u atio n p o stu la tes a ce rta in rela­
tion sh ip over tim e b etw een th e in d e p en d e n t variables
an d th e d ep en d en t variable — to tal sp en d in g. Using
ap p rop riate statistical p ro ced u res an d se le c te d m ea ­
su res o f variables, it is p o ssib le to test w h e th e r o r not
th e im p licatio n s o f th e red u ced -fo rm eq u atio n have
o ccu rred in th e past. If th e im plied rela tio n sh ip s are
not confirm ed , th e n th e rela tio n sh ip asserted by th e
red u ced -form eq u atio n is said to have b een refu ted.
However, not con firm in g th e red u ced form d o es not
n ecessa rily m ean th at th e w h o le “m o d el,” an d all of
th e factors an d ca u sa l relatio n s co n ta in e d in it, are
denied . It m ay b e on ly th at o n e o r m o re o f th e stru c­
tu ral linkages o f th e m od el is in co rrect, o r th at the
em p irical su rrogates c h o s e n as m e a su res o f m o n eta iy
o r fiscal in flu en ce are n ot a p p rop riate.1
1
Frequ en tly on e e n c o u n te rs sta tem e n ts o r c o n je c ­
tu res regarding factors w h ich are asse rte d to in flu en ce
eco n o m ic activity in a sp e cific w ay. T h e se sta tem en ts
take th e form o f red u ced -fo rm eq u atio n s, an d are
so m etim es a ttrib u ted to various th e o rie s o f th e d eter­
m ination o f e c o n o m ic activity. As sta ted previously,
th is stud y d oes n o t a ttem p t to test th e ca u sa l linkages
by w h ich fiscal an d m o n etary a ctio n s in flu en ce total
spending, b u t is co n c e rn e d only w ith th e co n firm a ­

8For a detailed discussion of testing hypotheses in reference to
monetary actions, see Albert E. Burger and Leonall C. Andersen,
“The Development of Testable Hypotheses for Monetary Manage­
ment,” a paper presented at the annual meeting of the Southern
Finance Association, November 8,1968. It will appear in a forthcom­
ing issue of the Southern Journal of Business, University of Georgia,
Athens, Georgia.
9A more specific statement relating to these considerations is pre­
sented in the appendix.

FEDERAL RESERVE BANK OF ST. LOUIS

tion o r refu tation o f rival co n je c tu re s regarding the
stren gth and reliability o f fiscal an d m o n eta iy actio n s
b ased on frequ ently u sed in d icato rs o f su ch actio n s.

Measuring the Empirical Relationships
As a step tow ard analyzing th e th ree p ro p o sition s
put forth earlier, em p irical relatio n sh ip s betw een th e
m easu res o f fiscal an d m o n eta iy a ctio n s an d total
sp en d in g are estab lish ed . T h e se relatio n sh ip s are d e ­
veloped by regressin g qu arter-to -q u arter ch an g es in
GNP on qu arter-to -q u arter ch an g es in th e m on ey
stock (M) and in th e various m e asu res o f fiscal actio n s:
h ig h -e m p lo y m e n t b u d g e t s u r p lu s (R -E ), h ig h em p loy m ent ex p en d itu res (E), and h ig h -em p loy m ent
receip ts (R). Sim ilar eq u atio n s w ere estim ated w here
ch a n g es in th e m o n eta iy b ase (B) w ere u sed in p la ce o f
th e m oney stock.
C hanges in all variables w ere co m p u ted by two
m eth o d s. C onventional fii-st d ifferen ces w ere c a lc u ­
lated by su btractin g th e value for th e p reced in g qu ar­
te r from th e value for th e p re sen t qu arter.'" T h e o th e r
m eth o d u sed is an averaging p ro ced u re used by Kareken an d Solow called cen tral d ifferen ces." T h e s tru c ­
ture o f lags p resen t in th e regressio n s w as estim ated
w ith u se o f th e Alm on lag tech n iq u e.'- T h e data are
season ally ad ju sted qu arterly averages for th e period
from th e first q u arter o f 1952 to the; seco n d q u arter o f
1 968.1
3

,0Changes in GNP, R, and E are quarterly changes in billions of
dollars measured at annual rates, while changes in M and B are
quarterly changes in billions of dollars. Changes in GNP, R, and E
are changes in flows, whereas changes in M and B are changes in a
stock. Since all of the time series have strong trends, first differ­
ences tend to increase in size over time. Statistical considerations
indicate that percent first differences would be more appropriate. On
the other hand, regular first differences provide estimates of multipli­
ers which are more useful for the purposes of this study. Test
regressions of relative changes were run and they did not alter the
conclusions of this article.
"John Kareken and Robert M. Solow, “Lags in Monetary Policy” in
Stabilization Policies of the research studies prepared for the Com­
mission on Money and Credit, Prentice-Hall, Inc., 1962, pp. 18-21.
12Shirley Almon, “The Distributed Lag Between Capital Appropria­
tions and Expenditures,” Econometrica, Vol. 33, No. 1, January
1965, pp. 178-96.
13As a test for structural shifts, the test period was divided into two
equal parts and the regressions reported here were run for each
sub-period and for the whole period. The Chow test for structural
changes accepted the hypothesis that the sets of parameters esti­
mated for each of the sub-periods were not different from each other
or from those estimated for the whole period, at the five percent level
of significance. As a result, there is no evidence of a structural shift;
consequently, the whole period was used.



OCTOBER 1986

As d iscu sse d previously, sta tem e n ts are frequ ently
m ad e from w h ich ce rta in rela tio n sh ip s are ex p ected
to exist b etw een m easu res o f e co n o m ic activity on the
on e h and an d m easu res o f m o n eta iy an d fiscal actio n s
on th e o th e r h an d . Su ch rela tio n sh ip s co n sist o f a
d irect in flu en ce o f an a ctio n on CiNP an d o f an in d irect
in flu en ce w h ich reflects in tera ctio n s am on g th e m any
m arkets for real an d fin an cial a ssets. T h e se in te ra c­
tio n s w ork th rou gh th e m arket m e ch a n ism d eterm in ­
ing th e d ep en d en t variables listed in exh ib it 1. T h e
p o stu lated relatio n sh ip s are th e total o f th e se d irect
an d in d irect in flu en ces. T h u s, th e em p irical rela tio n ­
ship em b od ied in e a c h regressio n co efficien t is th e
total re sp o n se (in clud in g b o th d ire ct an d in d irect re ­
spon ses) o f GNP to ch a n g es in e a c h m easu re o f a
stabilization actio n , assu m in g all o th e r fo rces rem ain
co n sta n t.
T h e resu lts p resen ted h ere do n o t provide a basis
for sep aratin g th e d irect an d in d irect in flu en ces o f
m o n eta iy an d fiscal fo rces on total spen din g, b u t this
division is irrelevant for th e p u rp o ses o f th is article.
T h e in tere ste d re a d e r is referred to th e ap p en d ix for
fu rth er elab o ratio n o f th e se poin ts.
Using th e total re sp o n se co n cep t, ch a n g es in GNP
are ex p e cted to b e positively related to ch a n g es in th e
m o n ey stock (M) o r ch a n g es in th e m o n eta iy b a se (B).
W ith regard to th e h ig h -em p loy m en t su rp lu s (receip ts
m inu s exp en d itu res), a larger su rp lu s o r a sm aller
d eficit is ex p e cted to have a negative in flu en ce on GNP,
an d conversely. C hanges in h ig h -em p loy m en t e x ­
p en d itu res (E) are ex p e cted to have a positive in ­
flu en ce an d ch a n g es in re ceip ts (R) are ex p e cted to
have a negative in flu en ce w h en th e se variables are
in clu d ed sep arately.
C on sid erin g th at th e prirnaiy p u rp o se o f th is study
is to m easu re th e in flu en ce o f a few m a jo r fo rces on
ch a n g es in GNP, ra th er th an to identify an d m easu re
th e in flu en ces o f all in d e p en d e n t forces, th e results
o b tain ed are qu ite good (table II. T h e K- statistic, a
m easu re o f th e p e rce n t o f th e v arian ce in ch a n g es in
GNP exp lain ed by th e regressio n eq u ation , ranges
from .53 to .73; th e se values are u sually co n sid ere d to
be qu ite good w h en first d ifferen ces are u sed ra th er
th an levels o f th e data. All o f th e estim ated regression
co efficien ts fo r ch a n g es in th e m o n ey stock o r th e
m o n eta iy b ase have th e signs im p lied in th e above
d iscu ssio n (equ ation s 1.1 to 2.4 in tab le 1) an d have a
high statistical sig n ifican ce in m ost ca ses. T h e esti­
m ated co efficien ts for th e h ig h -em p loy m en t m easu res
of fiscal in flu en ce do not have th e ex p e cted signs in all
ca ses an d gen erally are o f low statistical sign ifican ce.

35

OCTOBER 1986

FEDERAL RESERVE BANK OF ST. LOUIS

Table 1
Regression of Changes in GNP on Changes in Monetary and Fiscal Actions

First
Differences
t
t-1
t-2
t-3
Sum
Constant
R2
SE
DW
Central
Differences
t
t-1
t-2
t-3
Sum
Constant
R2
SE
DW

(Equation 1.1)
AM A(R-E)
1.57* -.1 5
(2.17) (.65)
1.94* -.20
(3.60) (1.08)
1.80*
.10
(3.37) (.55)
.47*
1.28
(1.88) (1.95)
.22
6.59*
(7.73) (.45)
1.99*
(2.16)
.56
4.24
1.54
(Equation 2.1)
AM A(R-E)
1.50 -.2 4
(1.84) (.91)
2.11* -.2 3
(3.61) (1.16)
.15
1.89*
(3.18) (81)
.52
1.06
(1.36) (1.90)
.21
6.56*
(8.16) (.47)
2.02*
(2.48)
.66
3.35
.88

AM
1.51*
(2.03)
1.59*
(2.85)
1.47*
(2.69)
1.27
(1.82)
5.84*
(6.57)
2.10
(1.88)
.58
4.11
1.80
AM
1.58*
(2.01)
1.57*
(2.78)
1.41*
(2.45)
1.26
(1.72)
5.80*
(7.57)
2.00*
(2.14)
.72
3.03
1.14

(Equation 1.2)
AE
AR
.36
.16
(1.15)
(.53)
.53*
-.01
(2.15)
(03)
-.0 5
-.03
(.19)
(.10)
.11
-.78*
(2.82)
(32)
.07
.23
(32)
(.13)

(Equation 1.3)
AM
AE
1.54*
.40
(2.47)
(1.48)
1.56*
.54*
(3.43)
(2.68)
1.44*
-.03
(3.18)
(.13)
-.74*
1.29*
(2.00)
(2.85)
5.83*
.17
(.54)
(7.25)
2.28*
(2.76)
.60
4.01
1.78

(Equation 2.2)
AR
AE
.53
.32
(1.52)
(1.05)
-.0 4
.60*
(2.44)
(.17)
-.11
-.1 5
(.60)
(.47)
-.96*
.18
(3.15)
(.48)
.02
.34
(04)
(.54)

(Equation 2.3)
AM
AE
1.54*
.63*
(2.45)
(2.21)
1.63*
.59*
(3.57)
(2.61)
1.43*
-.1 6
(.71)
(3.16)
1.13
-.86*
(3.07)
(1.71)
5.74*
.19
(.77)
(8.45)
2.30*
(3.55)
.73
2.97
1.13

AB
1.02
(.49)
5.46*
(3.37)
6.48*
(4.10)
3.05
(1.54)
16.01*
(5.67)
1.55
(1.22)
.53
4.35
1.71
AB
.61
(.28)
5.42*
(3.16)
6.87*
(3.92)
3.51
(1.71)
16.41*
(6.95)
1.24
(1.14)
.67
3.26
1.05

(Equation 1.4)
AE
AR
.52
.23
(67)
(1.68)
.02
.37
(1.36)
(07)
-.1 7
-.21
(84)
(.64)
.14
-.93*
(3.10)
(39)
-.5 4
.51
(.67)
(89)

(Equation 2.4)
AE
.28
(.73)
.50
(187)
-.2 7
(104)
-1.26*
(3.65)
-.7 5
(1.37)

AR
.87*
(2.55)
-.0 7
(.27)
-.3 3
(1.31)
.35
(87)
.82
(116)

Note: Regression coefficients are the top figures, and their “t” values appear below each coefficient enclosed by parentheses. The
regression coefficients marked by an asterisk (*) are statistically significant at the 5 percent level. R2 are adjusted for degrees of
freedom. SE is the standard error of the estimate, and DW is the Durbin-Watson statistic.

T h e se reg ressio n resu lts are d iscu sse d in g reater d e­
tail below .
M o n ey a n d th e m o n eta ry b a s e — T h e total re­
sp o n se o f GNP to ch an g es in m o n ey o r th e m o n eta iy
b ase d istribu ted over fou r q u arters is co n siste n t w ith
th e p o stu lated relatio n sh ip (i.e., a positive relatio n ­
ship), an d th e co efficien ts are all statistically signifi­
ca n t. T h e co efficien ts o f e a c h m e asu re o f m o n eta iy
a ctio n m ay be su m m ed to provide an in d icatio n o f the
overall re sp o n se o f GNP to ch an g es in m o n eta iy
actio n s. T h e se su m m ed co efficien ts are also statisti­

36




cally sign ifican t an d c o n siste n t w ith th e p o stu lated
relatio n sh ip s. T h e resu lts o b ta in ed for m e a su res o f
m o n eta iy a ctio n s w ere n ot affected sign ifican tly w h en
m easu res o f fiscal a ctio n s o th e r th a n th o se rep o rted
h ere w ere u sed in th e regressio n s.
H ig h -em p lo y m en t b u d g e t s u r p lu s — As p o in ted
out previously, th e h ig h -em p loy m en t su rp lu s o r d e­
ficit is often u sed a s a m e a su re o f th e d ire ctio n an d
stren g th o f fiscal actio n s. E q u atio n 1.1 su m m arizes the
total resp o n se o f GNP to ch a n g es in m o n ey an d
ch a n g es in th e h ig h -em p loy m en t su rp lu s. T h e co ef­

FEDERAL RESERVE BANK OF ST. LOUIS

ficien ts o f th e hig h -em p loy m en t su rp lu s estim ated for
th e co n tem p o ran eo u s an d first lagged q u a rte r have
th e ex p ected sign, bu t th e co efficien ts are o f veiy low
statistical sign ifican ce an d do not differ significantly
from zero. T h e signs o f th e co efficien ts estim ated for
th e seco n d and third lagged q u arters are o p p o site to
th e ex p ected signs. T h e su m o f th e co efficien ts (total
resp o n se d istribu ted over fou r quarters) is estim ated
to have a positive sign (op p osite th e p o stu lated sign)
but is not statistically significant. T h e se resu lts p ro ­
vide no em p irical su p p o rt for th e view that fiscal
actio n s m easu red by th e hig h -em p loy m ent su rp lu s
have a significant in flu en ce o n GNP. fn p rin cip le, th ese
resu lts m ay have o ccu rred eith e r b e c a u se th e highem p loy m ent su rp lu s w as n o t a good m easu re o f fiscal
in flu ence, o r b eca u se fiscal in flu en ce w as not im p o r­
tan t during th e sam p le p e rio d .1
4
E x p e n d itu re s a n d re c e ip ts — Sim ple textbook
K eynesian m o d els o f in co m e d eterm in atio n usually
d em onstrate, th eoretically, th at ch an g es in tax rates
exert a negative in flu en ce o n e c o n o m ic activity, w hile
ch an g es in governm ent ex p en d itu res exert a positive
in flu en ce. E qu atio n s 1.2 and 1.3 provide tests o f th ese
p rop ositions. T h e signs o f th e co efficien ts estim ated
for tax receip ts are th e sam e as th e h y p oth esized signs
for only th e first and se co n d lagged qu arters. However,
sin ce th ese co efficien ts (individually and the sum s)
are o f low statistical sign ifican ce, n o im p o rtan ce ca n
b e attach ed to this variable. In clu sio n o f ch an g es in
receip ts (AR) in eq u atio n 1.2 d o es n o t im prove the
overall results, in term s o f R2 and th e stan d ard erro r o f
estim ate, co m p ared w ith eq u atio n 1.3 from w h ich
receip ts are exclu ded .
T h ese resu lts provide n o su p p o rt for th e o rie s w h ich
in d icate that ch an g es in tax receip ts d ue to ch an g es in
tax rates exert an overall negative (or any) in flu en ce on
e co n o m ic activity. T h e resu lts are co n siste n t w ith th e ­
ories w h ich in d icate th at if th e alternative to tax reve­
n u e is borrow ing from th e p u blic in o rd er to fin an ce
governm ent spending, th en th e in flu en ce o f sp en d in g

14lt was suggested to the authors that a weighted high-employment
budget surplus might be a better measure of fiscal influence than the
usual unweighted series. For an elaboration of such a weighted
series, see Edward M. Gramlich, “Measures of the Aggregate
Demand Impact of the Federal Budget,” in Staff Papers of the
President’s Commission on Budget Concepts, U.S. Government
Printing Office, Washington, D.C., October 1967. Gramlich provided
weights from the FRB-MIT model of the economy for constructing a
weighted series. It was further suggested that the level of the highemployment budget surplus was a more appropriate measure of
fiscal actions. Coefficients of fiscal influence were estimated using
both changes in the weighted series, and levels of the highemployment surplus. The results did not change any of the conclu­
sions of this article.



OCTOBER 1986

will n ot n ecessa rily be g reater if th e fund s are b o r­
row ed ra th er th an o b tain ed th rou gh taxation . They
are also co n siste n t w ith th e th e o iy that co n su m ers
will m ain tain co n su m p tio n levels at th e ex p en se o f
saving w h en th ere is a tem p orary red u ctio n in d isp o s­
able in co m e.
T h e signs o f th e co efficien ts estim ated for highem ploym en t ex p en d itu res in eq u atio n s 1.2 an d 1.3
in d ica te th at an in cre a s e in govern m en t ex p en d itu res
is m ildly stim ulative in th e q u a rter in w h ich sp en d in g
is in crea sed an d in th e follow ing qu arter. However, in
th e su b seq u en t two qu arters this in crea se in e x p e n d i­
tu res ca u ses offsetting negative in flu en ces. T h e overall
effect o f a ch a n g e in ex p en d itu res d istrib u ted over
four quarter’s, in d ica ted by th e sum , is relatively sm all
an d n ot statistically significant. T h e se resu lts are c o n ­
sisten t w ith m o d ern qu an tity th eo ries w h ich h o ld that
governm ent spen din g, taxing, an d borrow ing p o licies
w ould have, th rou gh in tere st rate an d w ealth effects,
different im p acts on ec o n o m ic activity u n d e r varying
c irc u m sta n c e s.1
5

Three Propositions Tested
T h e em p irical re la tio n sh ip s d eveloped relating
ch a n g es in GNP to ch a n g es in th e m o n ey stock an d
ch a n g es in h ig h -em p loy m ent ex p en d itu res an d re­
ceip ts are u sed to test th e th ree p ro p o sition s u n d e r
co n sid eratio n . T h e resu lts o f testin g th e prop osition s
u sing ch a n g es in th e m oney stock are d iscu sse d in
detail in th is sectio n . Sim ilar resu lts are rep o rted in
th e acco m p an y in g tab les u sin g ch a n g es in th e m o n e­
tary b ase in stea d o f th e m o n ey stock. C o n clu sio n s
draw n using e ith e r m ea su re o f m on etary a ctio n s are
sim ilar.
P ro p o sitio n I sta tes th at fiscal a ctio n s exert a larger
in flu en ce on e c o n o m ic activity th an do m on etary
a ctio n s. A test o f th is p ro p o sition involves an ex am in a­
tion o f th e size o f th e reg ressio n co efficien ts for highem p lo y m en t ex p en d itu res r elative to th o se for- m on ey
an d th e m on etary b ase."1P rop osition I im plies th at the

15John Culbertson points out that in a financially constrained economy
(i.e., no monetary expansion to finance government expenditures),
expenditures by the government financed in debt markets in compe­
tition with private expenditures can very possibly “crowd out of the
market an equal (or conceivably even greater) volume that would
have financed private expenditures.” He asserts that it is possible to
have a short-lived effect of government spending on
total spending if the financial offsets lag behind its positive effects.
The results obtained for AE in this article are consistent with his
analysis. See John M. Culbertson, Macroeconomic Theory and
Stabilization Policy, McGraw-Hill, Inc., New York, 1968, pp. 462-63.
'6Since little response of GNP to AR was found, further discussions
consider only AE.

37

OCTOBER 1986

FEDERAL RESERVE BANK OF ST. LOUIS

Table 2
Measurements of the Relative Importance of Monetary and Fiscal Actions

Beta Coefficients
AB
AR

Quarter
AM
AE
First Differences (equations 1 .2 and 1 .4 )
.14
.05
t
.24
t-1
.26
.20
t-2
.24 -.0 2 -.01
.03
t-3
.20 - .30
.02
.07
Sum
.94

Central Differences (equations 2 .2 and 2 .4 )
t
.26
.20
.09
t-1
.26
.23 - .01
t-2
.23 - .06 - .03
.05
t-3
.20 - .36
Sum
.95
.01
.10

AE

AR

Partial Coefficients of Determination
AM AE AR AB
AE AR

.06
.31
.37
.17
.91

.09
.14
-.0 8
-.3 6
-.21

.16
.01
-.0 5
.04
.16

.07
.14
.12
.06
.45

.02
.08
*
.13
*

.01
*
*
*
*

*
.18
.24
.04
.38

.01
.03
.01
.16
.02

.05
*
.01
*
.01

.04
.31
.40
.20
.95

.11
.19
-.1 0
-.4 7
-.2 7

.25
-.0 2
-.09
.10
.24

.07
.13
.11
.05
.53

.04
.10
.01
.16
*

.02
*
*
*
.01

*
.16
.23
.05
.49

.01
.06
.02
.21
.04

.11
*
.03
.01
.03

’ Less than .005.

co efficien ts for AE w ould be larger, w ithou t regard to
sign, th a n th o se for AM an d AB.
T h e co efficien ts p resen ted in table 1 are n ot ap p ro ­
priate for th is test b ec a u se th e variables have different
tim e d im e n sio n s and are a m ixture o f sto ck s and
flow s. An ap p rop riate m easu re is developed by ch a n g ­
ing th e se reg ressio n co efficien ts to “b eta co e fficie n ts”
w h ich elim in ate th ese difficu lties (table 21. T h e se co e f­
ficien ts take in to co n sid eratio n the p ast variation o f
ch a n g es in e a c h in d ep en d en t variable relative to the
p ast variation o f ch an g es in GNP.1 T h e size o f b eta
7
co efficien ts m ay be, therefore, d irectly co m p ared as a
m easu re o f th e relative co n trib u tio n o f e a c h variable to
variations in GNP in th e test period.
A ccord ing to table 2, th e beta co efficien ts for
ch a n g es in m o n ey are g reater th an th o se for ch an g es
in h ig h -em p loy m en t ex p en d itu res for th e q u arter in
w h ich a ch an g e o cc u rs and during th e two follow ing
qu arters. T h e co efficien ts for ch an g es in th e m o n eta iy
b ase are g reater for th e tw o q u arters im m ediately
follow ing a ch an g e in th e b ase. In th e lagged qu arters
in w h ich th e b eta co efficien ts for AE are largest, a
negative sign is asso cia te d w ith th e reg ressio n co e f­
ficien t, in d icatin g a lagged c o n tra ctio n a iy effect o f

"Arthur S. Goldberger, Econometric Theory. John Wiley & Sons, Inc.,
December 1966, New York, pp. 197-200.

38




in crea sed ex p en d itu res. As a m easu re o f th e total
co n trib u tio n over th e fou r qu arters, th e su m o f th e
b eta co efficien ts for ch a n g es in m o n ey an d th e m o n e ­
ta iy b ase are m u ch g reater th a n th o se for ch a n g es in
exp en d itu res.
Proposition I m ay also be tested bv th e u se o f partial
co efficien ts o f d eterm in atio n . T h e se sta tistics are m e a ­
su res o f th e p e rce n t o f variation o f th e d ep e n d en t
variable rem ain ing after th e v ariation a c c o u n te d fo r by
all o th e r variables in th e reg ressio n h as b e e n su b ­
tra cted from th e total variation. P ro p o sitio n I im plies
th at larger co efficien ts sh o u ld b e o b seiv ed fo r fiscal
actio n s th an for m o n eta iy a ctio n s. T able 2 p re sen ts
th e partial co efficien ts o f d eterm in a tio n for th e vari­
ab les u n d e r co n sid era tio n . F o r th e q u a rte r o f a ch an g e
an d th e su b seq u en t tw o qu arters, th e se co efficien ts
for AM are m u ch g reater th a n th o se for AE. W ith
regard to AB, th e co efficien ts are abou t eq u al to th o se
for AE in th e first q u a rter an d are m u ch g rea ter in the
two su b seq u en t qu arters. T h e partial co e fficie n ts o f
d eterm in atio n for th e total co n trib u tio n o f e a c h policy
variable to ch a n g es in GNP over fo u r q u arters m ay b e
d eveloped. T ab le 2 show s th a t th e partial co efficien ts
o f d eterm in atio n for th e overall re sp o n se o f AGNP to
AM an d AB ran ge from .38 to .53, w h ile th o se fo r AE
are virtually zero.
O th er im p licatio n s o f th e resu lts p resen ted in table
1 m ay b e u sed to test fu rth er th e relative stren g th o f
th e re sp o n se o f GNP to alternative govern m en t a ctio n s

FEDERAL RESERVE BANK OF ST. LOUIS

OCTOBER 1986

Table 3
Simulated Response of an Increase in Government Expenditures Financed by
Monetary Expansion (millions of dollars)

Quarter
1
2
3
4
5
6
7
8

Increase in Government Expenditures
Impact Cumulative
Effect
Effect
Change in
Expenditures on GNP
on GNP
$1000
0
0
0
- 1000
0
0
0

-

$400
540
30
740
400
540
30
740

Required Increase in Money
Impact Cumulative
Change in
Effect
Effect
Money Stock on GNP
on GNP

$400
940
910
170
- 230
- 770
- 740
0

u n d e r co n d itio n s w h ere “o th e r th in g s” are held c o n ­
stant. T h ree alternative actio n s are assu m ed taken by
stabilization au th o rities: (1) th e rate o f govern m en t
sp en d ing is in crea sed by $1 billion an d is fin an ced by
e ith e r borrow ing from the p u blic o r in creasin g taxes;
(2) th e m o n ey sto ck is in crea sed by $1 billion w ith no
ch an g e in th e budget positio n ; an d (3) th e rate of
governm ent sp en d in g is in crea sed by $1 billion for a
y ea r an d is fin an ced by in creasin g th e m on ey sto ck by
an equal am ount.
T h e im p act on total sp en d in g o f th e first two actio n s
m ay be m easu red by u sing th e su m s o f th e regression
coefficien ts p resen ted for eq u atio n 1.3. A $1 billion
in crease in th e rate o f governm ent sp en d in g w ould,
after four qu arters, resu lt in a p erm an en t in crea se o f
$170 m illion in GNP. By co m p ariso n , an in cre a se o f the
sam e m agnitu d e in m o n ey w ould resu lt in GNP being
$5.8 billion p erm an en tly h ig h er after fou r qu arters.
T h e resu lts o f the last actio n are p re sen ted in table
3.'“ T h e ann u al rate o f governm ent sp en d in g is a s­
su m ed to be in creased by $1 billion in th e first q u arter
an d h eld at that rate for th e follow ing th ree qu arters.
T his w ould requ ire an in crea se in m o n ey o f $250
m illion d uring e a c h o f th e fou r q u arters to fin an ce the
h ig h er level o f exp en d itu res. Sin ce w e are in terested
only in th e result o f finan cing th e original in crea se in
1The authors wish to give special thanks to Milton Friedman for
B
suggesting this illustration and table 3. However, the formulation
presented here is the sole responsibility of the authors.



$250
250
250
250
0
0
0
0

$ 385
775
1135
1458
1072
682
323
0

$ 385
1160
2295
3753
4825
5507
5830
5830

Total Response in GNP
Impact Cumulative
Effect
Effect
on GNP
on GNP
$ 785
1315
1105
718
672
142
353
740

$ 785
2100
3205
3923
4595
4737
5090
5830

ex p en d itu res by m o n eta iy exp an sio n , ex p en d itu res
m u st b e red u ced by $1 b illion in th e fifth qu arter. If
ex p en d itu res w ere h eld at th e h ig h er rate, m on ey
w ould have to co n tin u e to grow at $250 m illion p er
quarter. A ccord ing to table 3, GNP w ould rise to a
p erm an en t level $5.8 b illion h ig h er th an at th e b eg in ­
ning. T h is in crea se in GNP resu lts en tirely from m o n e ­
tary expan sion .
A ccord in g to th e se th ree tests, th e reg ressio n resu lts
im plied by P rop osition I did n o t o ccu r. T h erefo re, th e
p ro p o sition th at th e re sp o n se o f total d em an d to fiscal
a ctio n s is g reater th a n th at o f m o n eta iy a ctio n s is n ot
confirm ed by th e evidence.
P ro p o sitio n l i hold s that th e re sp o n se o f eco n o m ic
activity to fiscal a ctio n s is m o re p red ictab le th a n th e
resp o n se to m o n eta iy in flu en ce. T h is im p lies th at the
regression co efficien ts relative to th eir stan d ard errors
(this ratio is called th e “t-value”), relatin g ch a n g es in E
to ch a n g es in GNP, sh o u ld b e g rea ter th an th e co rre s ­
p on d in g m easu res for ch a n g es in M an d in B. T h e
g reater the t-value, th e m o re co n fid e n ce th ere is in th e
estim a ted reg ressio n co efficien t, an d h en ce, th e
g reater is th e reliability o f th e estim a ted ch a n g e in
GNP resu lting from a ch a n g e in th e variable. T h e se tvalues are p resen ted in table 4.
An exam in ation o f th is table in d ica tes g rea ter tvalues for th e regressio n co efficien ts o f th e tw o m o n e­
tary variables th an for th e fiscal variable, ex cep t for the
third q u arter after a ch an g e. Also, th e t-values for th e

39

OCTOBER 1986

FEDERAL RESERVE BANK OF ST. LOUIS

Table 4
Measurement of Reliability of the Response of GNP to Monetary
and Fiscal Actions (“t-values” of regression coefficients1
)

Quarter
First Differences
t
t-1
t-2
t-3
Sum

AM

AE

AR

AB

AE

AR

2.03
2.85
2.69
1.82
6.57

1.15
2.15
0.19
2.82
0.13

0.53
0.03
0.10
0.32
0.32

0.49
3.37
4.10
1.54
5.67

0.67
1.36
0.84
3.10
0.89

1.68
0.07
0.64
0.39
0.67

Central Differences
t
t-1
t-2
t-3
Sum

2.01
2.78
2.45
1.72
7.57

1.52
2.44
0.60
3.15
0.04

1.05
0.17
0.46
0.48
0.54

0.28
3.16
3.92
1.71
6.95

0.73
1.87
1.04
3.65
1.37

2.55
0.27
1.31
0.87
1.16

’t-values associated with equations 1.2,1.4, 2.2 and 2.4 in table 1.

sum o f th e regression co efficien ts for AM an d AB are
large, w hile th o se for AE are n o t statistically significant
from zero. Sin ce th e reg ressio n resu lts im p lied by
Proposition II did not appeal', th e p ro p o sition is not
con firm ed.
P ro p o sitio n III states th at th e in flu en ce o f fiscal
a ctio n s o n e co n o m ic activity o cc u rs faster th an th at o f
m o n etaiy actio n s. It is tested by exam in ing the c h a ra c ­
te ristics o f th e lag stru ctu re in th e regressio n s. P rop o­
sition III im plies that beta co efficien ts for AE should
b e g reater th an th o se for AM in th e q u arte r o f a ch an g e
an d in th o se im m ed iately follow ing. It also im plies
th at th e m ain resp o n se o f GNP to fiscal actio n s o cc u rs
w ith in few er qu arters th an its re sp o n se to m o n eta iy
a ctio n s.
T h e b eta co efficien ts are plotted in th e ch a r ts .1 A
”
ch an g e in th e m o n ey stock in d u ce s a large an d alm ost
equal re sp o n se in each o f th e fou r q u arters. T h e larg­
est re sp o n se o f GNP to ch an g es in the m o n eta iy base

19The Almon lag structure was developed by using a fourth degree
polynomial and constraining the coefficients for t-4 to zero. The
regressions indicate that four quarters constitute an appropriate
response period for both fiscal and monetary actions. Equations
using up to seven lagged quarters were also estimated, but there
was little response in GNP to fiscal and monetary actions beyond
the three quarter lags reported.

40




o cc u rs in th e first an d se c o n d q u arters after a ch an g e.
T h e b eta co efficien ts for ch a n g es in M are g rea ter th an
th o se for ch a n g es in E for th e q u a rte r o f a ch a n g e an d
th e follo w in g q u a rte r, in d ic a tin g c o m p a ra tiv e ly
sm aller re sp o n se o f GNP to fiscal a ctio n s in th e se first
tw o qu arters. M oreover, th e largest co efficien t for AE
o cc u rs for th e third q u a rter after a ch an g e.
T h e ex p ected regressio n re su lts im p lied by P ro p o si­
tion III w ere n o t found. T h erefo re, th e p ro p o sition th at
th e m a jo r im p a ct o f fiscal in flu en ce on e c o n o m ic
activity o cc u rs w ith in a sh o rte r tim e in teiv al th an
m o n eta iy in flu en ce is n ot con firm ed .
S u m m a ry — T h is sectio n tested th e p ro p o sitio n s
that th e re sp o n se o f e c o n o m ic activity to fiscal a ctio n s
relative to m o n eta iy a ctio n s is (I) larger, (II) m ore
p red ictab le an d (III) faster. T h e resu lts o f th e tests
w ere not co n siste n t w ith any o f th e se p ro p o sition s.
C on sequen tly, e ith e r th e co m m o n ly u sed m e a su res o f
fiscal in flu en ce do n ot co rrectly in d ica te th e d egree
an d d ire ctio n o f su ch in flu en ce, o r th e re w as n o m ea ­
su rable n et fiscal in flu en ce on to tal sp en d in g in th e
test period.
T h e test resu lts are co n s is te n t w ith an alternative
set o f p ro p o sition s. T h e re sp o n se o f e c o n o m ic activity
to m on etary a ctio n s co m p a red w ith th at o f fiscal
a ctio n s is (I') larger, (II') m o re p red ictab le, an d (III')
faster. It sh ould b e rem em b ered that th ese alternative

FEDERAL RESERVE BANK OF ST. LOUIS

OCTOBER 1986

mm

M easu res of Lag Response
E q u a tio n 1.2

First Differences

E q u a tio n 1.4

E quation 2.2

Central Differences

Equation 2 .4

Beta coefficients are for changes in the money stock (AM), the monetary base (AB), high-employment
expenditures (AE), and high-employment receipts (AR). These beta coefficients are calculated as the products
of the regression coefficient for the respective variables times the ratio of the standard deviation of the variable
to the standard deviation of GNP.




41

FEDERAL RESERVE BANK OF ST. LOUIS

p ro p o sitio n s have n o t b een proven true, bu t th is is
alw ays th e ca se in scien tific testin g o f h y p oth esized
rela tio n sh ip s. N evertheless, it is asse rte d h ere that
th e se alternative p ro p o sition s are ap p rop riate fo r the
co n d u ct o f stabilizatio n policy until evid en ce is p re­
sen ted proving o n e o r m ore o f th em false.
T h e re is a m a jo r qu alification to th e se statem en ts.
Sin ce th e p ro p o sitio n s w ere tested u sin g th e period
first q u arter 1952 to seco n d q u arter 1968, it is im p lic­
itly a ssu m ed in m aking th e se sta tem e n ts that th e
gen eral en viron m en t prevailing in th e test period
h old s for th e im m ed iate future.

Implications for Economic
Stabilization Policy
R ejectio n o f th e th ree p ro p o sition s u n d e r ex am in a ­
tion and a c c e p ta n c e o f th e alternatives offered c a n y
im p ortant im p licatio n s for th e co n d u ct o f e c o n o m ic
stab ilization policy. All o f th e se im p licatio n s p o in t to
th e advisability o f g reater re lia n ce b ein g p laced on
m o n eta iy a ctio n s th a n on fiscal actio n s. Su ch a reli­
a n ce w ould re p rese n t a m arked d ep artu re from m ost
p resen t p ro ced u res.
T h e finding th at sta tem e n ts w h ich assert that
ch a n g es in tax rates have a significant in flu en ce on
total sp en d in g are not su p p o rted bv th is em pirical
investigation su ggests th at p ast efforts in th is regard
have b ee n overly o p tim istic. F u rth erm o re, th e finding
th at th e re sp o n se o f total sp en d in g to ch an g es in
governm ent ex p en d itu res is sm all co m p ared w ith the
re sp o n se o f sp en d in g to m o n e ta iy actio n s strongly
su ggests that it w ould be m o re ap p rop riate to place
g reater relian ce on th e latter form ol stabilization
a ctio n .
Find ing o f a stron g em p irical re latio n sh ip b etw een
e c o n o m ic activity and e ith e r o f th e m easu res o f m o n e­
ta iy a ctio n s p o in ts to th e co n c lu sio n th at m o n eta iy
a ctio n s can an d sh o u ld play a m ore p ro m in en t role in
ec o n o m ic stabilization th an they have up to now .
Fu rth erm o re, failure to reco gn ize th e se relatio n sh ip s
ca n lead to u n d esired ch an g es in e c o n o m ic activity
b eca u se o f th e relatively sh o rt lags and stron g effects
attribu table to m o n etaiy actio n s.
Evid ence w as found w h ich is c o n siste n t w ith the
pro p o sition th at th e in flu en ce o f m o n eta iy a ctio n s on
e co n o m ic activity is m o re ce rta in th a n th at o f fiscal
actio n s. Sin ce m o n etaiy in flu en ce w as also fou nd to
be stro n g er and to o p erate m ore quickly th a n fiscal
in flu en ce, it w ould ap p e ar to b e inap p rop riate, for
stabilization pu rp oses, for m o n eta iy au th o rities to

42




OCTOBER 1986

w ait veiy long for a d esired fiscal a ctio n to b e ad o p ted
an d im p lem en ted .
E vid ence fou n d in th is stud y su ggests th at the
m oney sto ck is an im p o rtan t in d ica to r o f th e total
th ru st o f stab ilization actio n s, b o th m o n etary an d
fiscal. T h is poin t is argued on tw o g ro u n d s. First,
ch a n g es in th e m on ey sto ck reflect m ainly w h at m ay
be ca lled d iscretio n ary a ctio n s o f th e F ed eral Reserve
System as it u ses its m a jo r in stru m en ts o f m o n etary
m an ag em en t — o p en m arket tra n sa ctio n s, d isco u n t
rate ch an g es, an d reserve requ irem en t ch a n g es. S e c­
ond, th e m on ey stock reflects th e jo in t a ctio n s o f the
T re a su iy an d th e F ed eral Reserve System in fin an cin g
new ly crea ted govern m en t d ebt. Su ch a ctio n s are
based on d ecisio n s regarding th e m o n etiz a tio n o f new
d ebt by Fed eral Reserve a ctio n s, an d T reasu ry d e c i­
sion s regarding ch an g es in its b a la n ces at Reserve
banks an d co m m ercia l banks. A ccord in g to th is s e c ­
ond point, ch a n g es in govern m en t sp en d in g fin an ced
by m o n eta iy ex p an sio n are reflected in ch a n g es in th e
m o n etary b a se an d in th e m o n ey stock.
A n u m b er o f eco n o m ists m ain tain th at th e m a jo r
in flu en ce o f fiscal a ctio n s re su lts o n ly if e x p en d itu res
are fin an ced by m o n eta iy ex p a n sio n . In p ractice, the
Fed eral Reserve d oes n o t buy secu rities from th e Gov­
ern m en t. In stead , its o p en m arket o p era tio n s an d
o th e r a ctio n s provide fund s in th e m arkets in w h ich
both th e governm ent an d private sector's borrow .
T h e relatio n sh ip s exp ressed in table 1 m ay b e u sed
to p ro ject th e ex p ected co u rse o f GNP, given a lte rn a ­
tive assu m p tio n s about m o n eta iy an d fiscal a ctio n s.
Su ch p ro jectio n s n ecessa rily a ssu m e th at th e en v iron ­
m en t in th e period u sed for estim a tio n an d th e aver­
age relatio n sh ip s o f th e re ce n t p ast h o ld in th e future.
T h e p ro jectio n s are n ot able to take in to co n sid era tio n
the in flu en ces o f o th e r in d e p en d e n t forces; th erefore,
they are n o t su itable for ex a ct fo recastin g p u rp o ses.
However, th ey do provide a u seful m easu re o f m o n e­
tary an d fiscal in flu en ces on ec o n o m ic activity.
An exam p le o f su ch p ro jectio n s u sin g eq u atio n 1.3
is p re sen ted in table 5. E qu atio n 1.3 related q u arter-to q u arter ch an g es in GNP to ch a n g es in th e m o n ey stock
an d ch a n g es in h ig h -em p loy m en t ex p en d itu res, b o th
d istrib u ted over four qu arters.
A ssu m ptions u sed in co m p u tin g th e p ro je c tio n s of
qu arterly ch a n g es in GNP rep o rted in table 5 in clu d e:
(a) h igh -em p loym ent ex p en d itu res w ere p ro jecte d
th rou gh th e se c o n d q u a rte r o f 1969 u n d e r th e a s­
su m p tio n th at federal sp en d in g in fiscal 1969 w ill be
about 5 p e rce n t (or $10 billion) g rea ter th a n fiscal 1968;

FEDERAL RESERVE BANK OF ST. LOUIS

OCTOBER 1986

(b) federal sp en d in g w as a ssu m ed to co n tin u e in ­
creasin g at a 5 to 6 p ercen t rate in the first two qu arters
o f fiscal 1970; an d (c) q u a rter-to -q u a rter ch a n g es in the
m on ey stock w ere p ro jecte d from 111/68 to IV/69 for
fou r alternative co n sta n t an n u al grow th rates for
m oney: 2 p ercen t, 4 p ercen t, 6 p e rce n t, an d 8 p ercen t.

Table 5
Projected Change in GNP with
Alternative Rates of Change in
Money Stock1

Assumed Rates of Change in
Money Stock2
Quarter
1968/III3
IV
1969/1
II
III
IV

2%

4%

6%

8%

17.9
14.6
12.0
11.0
6.8
8.0

17.9
16.0
15.0
15.2
12.3
13.7

17.9
17.5
18.0
19.4
18.0
19.4

17.9
19.0
20.7
23.7
23.4
25.2

'First differences of quarterly data. All variables are in billions of
dollars. Projections are based on coefficients of equation 1.3 in
table 1.
2Assumed alternative rates of change in the money stock from
III/68 to IV/69.
Preliminary estimate by the Department of Commerce.

T h e h ig h est grow th rate o f th e m on ey stock (8 p er­
cent) in d icates co n tin u ed rapid rates o f ex p an sio n in
GNP d uring th e next five qu arters. T h e slow est grow th
rate o f m o n ey (2 p ercen t) in d ica tes so m e slow ing o f
GNP grow th in the fourth q u a rte r o f th is y e a r and
fu rth er grad ual slow ing th rou gh o u t m o st o f n ext year.
T h e p ro jectio n s in d ica te that if th e re cen t d e c e le r­
ated grow th in th e m o n ey stock (less th a n 4 p ercen t
from Ju ly to O ctober) is co n tin u ed , an d grow th o f
governm ent sp en d in g is at abou t th e rate in d icated
above, the eco n o m y w ould probably re a ch a n o n in flatio n aiy grow th rate o f GNP in about th e third
q u a rter o f 1969 an d w ould th e n a cc e le ra te slightly.
T h e se p ro jectio n s, o f co u rse, m ake no assu m p tio n s
regarding th e V ietnam War, strikes, ag ricu ltu ral situ a ­
tions, civil d iso rd ers o r any o f the m any o th e r n o n c o n ­
trol lable exo g en o u s forces.

Appendix 1
T h e s p e cific h y p o th e sis u n d erly in g th e an aly sis in th is
stu d y is e x p re sse d by th e fo llo w ing re latio n :

If th is re la tio n (2) w ere e m p irica lly e stim a te d , th e follow ing
w ou ld b e obtained:-'

(1) Y = f (E, R, M, Z),

(3) AY = a.AE + ouAR + a:,AM + a,AZ,

w h e re: Y = total sp en d in g ,
E = a variable su m m a riz in g g o v ern m en t
e x p e n d itu re a c tio n s ;
R = a variable su m m a riz in g g o v ern m en t
taxin g a c tio n s ;
M = a variable su m m a riz in g m o n e ta iy a c tio n s ;
Z = a variable su m m a riz in g all o th e r fo rees
th a t in flu e n c e total sp e n d in g .2
E x p re ssin g th is relatio n in te rm s o f th e c h a n g e s o f e a ch
variable y ie ld s:
(2 ) Ay = f (Ae, a r , Am, a z ) .

1The authors would like to give special thanks to Karl Brunner for
useful discussion regarding the points made in this note.
2See exhibit 1 for a listing of "other forces” which influence total
spending.



w h ere th e valu es fo r a „ a ,, a „ an d ot4 are
re g re ssio n o f th e o b serv ed v alu es o f AY o n
valu es o f AE, AR, AM, a n d AZ. In (3) th e
c o e fficie n ts ( a ’s) are th e to tal re s p o n s e o f AY
e a c h o f th e fo u r in d e p e n d e n t variab les.

e stim a te d by
th e o b se iv e d
v alu e o f the
to c h a n g e s in

As d is c u ss e d in th e text, tim e se rie s fo r E, R, a n d M have
b e e n s e le c te d o n th e b asis o f fre q u en tly u sed in d ic a to rs o r
m e a su res o f fiscal a n d m o n e ta iy a c tio n s . T h e p u rp o se o f
th is stu d y w as to te st so m e fre q u en tly e n c o u n te re d rival
c o n je c tu r e s reg ard in g th e in flu e n c e o f fiscal an d m o n e ta iy
fo rce s o n e c o n o m ic activity, n o t to q u an tify all fo rc e s in ­
flu e n cin g o u r e co n o m y . T h e re fo re , a tte n tio n h e re h a s b e e n
d ire c te d tow ard e stim a tin g th e m a g n itu d e an d sta tistic a l

3For purposes of this note the lags of the independent variables are
ignored.

43

OCTOBER 1986

FEDERAL RESERVE BANK OF ST. LOUIS
reliability o f th e re s p o n s e o f AY to AE, AR, a n d AM. H owever,
AZ c a n n o t b e sim p ly ign o red .
T h e re a d e r w ill n o te th at th e re is n o c o n sta n t te rm in
eq u a tio n (3) s in c e th e e ffe ct o f "all o th e r fo rc e s " in flu e n cin g
sp e n d in g are su m m arize d by a,A Z. H owever, in th e re su lts
re p o rte d in tab le 1 o f th is stu d y, a c o n s ta n t te rm is re p o rte d
fo r e a c h e q u a tio n . T h e s e c o n sta n t te rm s a re an e stim a te o f
a , tim e s th e average a u to n o m o u s n o n -m o n e ta iy a n d n o n ­
fiscal fo rce s s u m m a riz e d in Z.
In a co m p le x m arket e co n o m y , it is p o ssib le fo r m o n e ta iy
an d fiscal a c tio n s to exert an in d ire c t a s w ell as a d ire c t
in flu e n ce on AY. T h is in d ire c t in flu e n c e w o u ld o p e ra te
th ro u g h AZ. O ne fo im o f th e re la tio n b e tw e e n AZ an d
m o n e ta iy an d fiscal fo rc e s is sh o w n by:
(4) AZ = b„ + b,AK + b,AR + b:,AM.
T h e e m p irica l v alu es o f a „ a , a n d a „ w h ic h w e re e sti­
m ated by re g re ssio n an aly sis an d re p o rte d in th is stud y,
e m b o d y b o th th e d irec t an d th e in d ire c t re s p o n s e s o f total
sp e n d in g to m o n e ta iy an d fiscal a c tio n s . U sing AE as an
exam p le, th e e x p re ssio n (a, + b ,a j is an e stim a te of a „ the
to tal re s p o n s e o f AY to AE. T h e d ire c t re s p o n s e is a,, a n d th e
in d ire ct re s p o n s e is b ,a 4. C o n se q u e n tly , th e e q u a tio n e s ti­
m ated an d re p o rte d in th is stu d y (for e xam p le, e q u a tio n 1.2
in tab le II is:
(51 AY = b„a, + (a, + b ,a 4)AE + la, + b,a,)A R + (a:l + b ,a4)AM;
w h ere b„a4 is th e “c o n s ta n t” re p o rte d in tab le 1. It it w ere
kn ow n th a t b „ b , a n d b , ar e z e ro , it co u ld b e c o n c lu d e d th at
th e re are n o in d ire c t e ffe cts o f m o n e ta iy an d fiscal fo rces
o p e ra tin g th ro u g h Z o n Y, o n ly d ire c t e ffe cts w h ic h are

44




m e a su re d by a,, a, an d a,. S in ce th is c a n n o t b e e sta b lish e d
co n clu siv e ly , it c a n n o t b e ru le d o u t th a t AZ m ay in c lu d e
so m e in d ire c t m o n e ta iy a n d fiscal fo rc e s in flu e n c in g e c o ­
n o m ic activity.
T h e c o n s ta n t term is e stim a te d to b e q u ite large an d
sta tistic a lly sig n ifican t. T h is p ro v id es in d ire c t e v id e n c e th a t
AZ is e x p la in e d to so m e e x te n t b y fa c to rs o th e r th a n AE, AR,
an d AM. T h e valu e o f b„a, is a m e a su re o f th e average effect
o f “o th e r fo r c e s ” o n AY, w h ic h o p e ra te th ro u g h AZ.
As a n o th e r te st o f th e in d e p e n d e n c e o f AZ from m o n e ta iy
a n d fiscal fo rc e s, th e total tim e p erio d w as d ivided in to tw o
s u b -sa m p le s an d th e e q u a tio n s w e re e stim a te d fo r th e s e
s u b -sa m p le s. T h e C h ow te st (see text) w as a p p lied to th e
s e ts o f re g re ssio n c o e fficie n ts e stim a te d from th e s u b -s a m ­
p les c o m p a re d to th e w h o le sa m p le ; th e h y p o th e sis th at
th e re w e re n o s tru c tu ra l sh ifts in th e tim e p e rio d c o u ld not
b e re je c te d , im p lyin g no c h a n g e in th e siz e o f b„a4. If th e re
w ere a sig n ifican t in d ire c t in flu e n c e o f AE, AR, a n d AM
o p e ra tin g th ro u g h AZ, b„a4 w o u ld c h a n g e a lo n g w ith
c h a n g e s in th e s e in d e p e n d e n t v ariab les. S in ce th is in te r­
c e p t w as fo u n d to b e s ta b le ov er th e te st p erio d , th is p ro ­
v id es fu rth e r e v id e n ce th at AZ is in flu e n c e d b y fa c to rs o th e r
th a n m o n e ta iy a n d fiscal fo rc e s.
T h e re s u lts from th e s u b -s a m p le s in d ic a te th a t th e re
w ere d iffe re n c e s in th e relativ e v ariability o f th e in d e p e n ­
d en t v ariab les b e tw e e n th e tw o s u b -s a m p le s. T h is te n d s to
s tre n g th e n th e c o n c lu s io n s o f th is a rticle s in c e th e re ­
s p o n s e o f AGNP to AM o r AB w as g re a te r ev en in th e first
s u b -sa m p le (1/53 to 1/60) in w h ic h th e variability o f AM an d
AB w as s m a lle r th a n th e variability o f AE an d AR.

T h e follow ing article is re p rin te d fro m the A pril 1970
F e d e ra l R eserv e Bank o f St. Louis Review.

A M onetarist Model for Econom ic
Stabilization
Leonall C. Andersen and Keith M. Carlson

T

HE m o n etarist view th at ch an g es in th e m o n ey
stock are a prim ary d eterm in an t o f ch an g es in total
spending, and should th ereb y b e given m a jo r e m p h a ­
sis in e co n o m ic stabilization program s, h as b ee n o f
grow ing in terest in re ce n t y ears. From th e m id -1980s
to the m id-1960s, m o n etaiy p o licy received little e m ­
p h asis in e co n o m ic stabilization policy. P resu m ed
failure o f m on etary p olicy d uring th e early y ears o f the
G reat D epression , along w ith th e d evelopm ent and
gen eral a cc e p ta n ce o f K eyn esian eco n o m ics, resu lted
in a m ain em p h asis on fiscal a ctio n s — fed eral gov­
ern m en t sp en d in g an d taxing program s — in e c o ­
n o m ic stabilization plans. M onetary policy, in so fa r as
it received any atten tio n , w as gen erally ex p ressed in
term s o f m arket rates o f in terest.
Growing recogn ition o f th e im p o rtan ce o f m o n ey
an d o th e r m o n etary aggregates in th e d eterm in atio n
o f spending, output, and p rice s h as b ee n fostered by
th e ap p arent failure o f stabilizatio n p o licy to cu rb th e
inflation o f th e last h a lf o f th e 1960s. Sharply rising
m arket in terest rates w ere in terp reted to in d icate
significant m o n etaiy restraint, w hile th e R evenue an d
E xp en d itu re C ontrol Act o f 1968 w as co n sid ere d a
m a jo r m ove tow ard fiscal restraint.

Offering helpful suggestions throughout the study were Denis
Karnosky of this Bank, William P. Yohe of Duke University and Visiting
Scholar at this Bank, 1969-70, and David Fand of Wayne State
University. Susan Smith provided programming assistance and Chris­
topher Babb and H. Albert Margolis advised on statistical problems.
The authors thank the following for their comments on earlier drafts,
without implying their endorsement of either the methods of analysis or
the conclusions: F. Gerard Adams, Philip Cagan, E. Gerald Corrigan,
Richard Davis, Ray Fair, Edgar Fiedler, Milton Friedman and members
of the Money and Banking Workshop at the University of Chicago,
Edward Gramlich, Harry G. Johnson, John Kalchbrenner, Edward
Kane, Michael Keran, Allan Meltzer, Franco Modigliani, George Morri­
son, David Ott, Joel Popkin, Thomas Saving, Roger Spencer, Henry
Wallich, Clark Warburton, Manfred Willms, and Arnold Zellner.



D espite th ese policy d evelopm en ts, total sp en d in g
co n tin u ed lo rise rapidly u ntil late 1969, an d th e rate of
inflation a ccelera ted . T h o se h old ing to th e m o n etarist
view w ere n ot su rp rised by th is lack o f s u c c e s s in
cu rb in g excessive grow th in total spen din g, largely
b eca u se th e m on ey stock grew at a h istorically rapid
rate d uring th e fou r y ea rs en d in g in late 1968. E c o ­
n o m ic d evelop m en ts from 1965 th rou gh 1969 w ere in
g en eral ag reem en t w ith th e ex p e cta tio n s o f th e m o n e­
tarist view.
T h is article develops a m od el d esign ed to analyze
eco n o m ic stab ilization issu e s w ithin a fram ew ork
w h ich focu ses on th e in flu en ce o f m o n eta iy ex p a n ­
sion on total spen din g. M ost o f th e m a jo r eco n o m etric
m od els have n ot a ssign ed an im p o rtan t role to th e
m on ey stock or to an y o th e r m o n eta iy aggregate.'
Fu rth erm ore, m o st eco n o m etric m o d els co n ta in a
large n u m b er o f behavioral h y p o th eses to b e em piri-

'Frank de Leeuw and Edward M. Gramlich, “The Federal ReserveMIT Econometric Model,” Federal Reserve Bulletin (January 1968),
pp. 11-40, and “The Channels of Monetary Policy: A Further Report
on the Federal Reserve MIT Econometric Model,” Federal Reserve
Bulletin (June 1969), pp. 472-91; James S. Duesenberry, Gary
Fromm, Lawrence R. Klein, and Edwin Kuh (ed.), The Brookings
Quarterly Econometric Model of the United States (Chicago: Rand
McNally, 1965), and The Brookings Model: Some Further Results
(Chicago: Rand McNally, 1969); Michael K. Evans and Lawrence R.
Klein, The Wharton Econometric Forecasting Model, 2nd Enlarged
Edition (Philadelphia: University of Pennsylvania, 1968); Maurice
Liebenberg, Albert A. Hirsch, and Joel Popkin, “A Quarterly Econo­
metric Model of the United States: A Progress Report," Survey of
Current Business (May 1966), pp. 423-56; Daniel M. Suits, “The
Economic Outlook for 1969,” in The Economic Outlook for 1969,
papers presented to the Sixteenth Annual Conference on the Eco­
nomic Outlook at The University of Michigan (Ann Arbor: University
of Michigan, 1969), pp. 1-26. For a discussion of the role of money
in these models, see David I. Fand, “The Monetary Theory of Nine
Recent Quarterly Econometric Models of the United States,” forth­
coming in the Journal of Money, Credit, and Banking.
45

FEDERAL RESERVE BANK OF ST. LOUIS

cally estim ated and in tegrated w ith ea ch oth er, b e ­
ca u se th ey are d esigned to aid in u n d erstan d in g th e
d eterm in atio n o f m any ec o n o m ic m ag n itu d es. By
co m p ariso n , th e m odel p resen ted in th is article is
qu ite sm all. It is d esigned to provide in form ation on
th e m o st likely co u rse o f m ovem ent o f ce rta in strategic
eco n o m ic variables in re sp o n se to m o n eta iy an d fiscal
actio n s.
T h e m o d el p re sen ted h ere is th e a u th o rs’ ow n ver­
sion o f h o w m o n etary an d fiscal a ctio n s in flu en ce th e
eco n om y. O ther eco n o m ists (includ ing th o se o f a
m o n etarist persu asion ) m ay p refer to develop certa in
a sp e cts o f th e m o d el in a different w ay. Tw o su ch
m o d ification s are p re sen ted in ap p en d ix C. T h e
m od el is co n sid ere d o p en to revision, bu t is p resen ted
at th is tim e w ith a view to stim u latin g o th e rs to jo in in
quantifying relatio n sh ip s th at are g en erally a sso cia te d
w ith the m o n etarist view.
T h is article is divided in to five m a jo r sectio n s. A
gen eral m o n etarist view o f th e re sp o n se o f spendin g,
o utput, and p rices to m o n eta iy an d fiscal a ctio n s is
su m m arized first. Next, th e sp e cific featu res o f th e
m od el are d iscu sse d w ithin a form al fram ew ork o f
analysis. S tatistical estim ates o f th e m o d e l’s p ara m e­
ters are p re sen ted in th e third se ctio n . T h e fou rth
sectio n te sts th e p erfo rm an ce o f th e m o d el w ith sev­
eral d ynam ic sim u lation ex p erim en ts. Finally, by sim ­
u latin g th e re sp o n se o f th e eco n o m y to alternative
rates o f m o n e ta iy exp an sio n , an illu stration is p ro ­
vided o f h o w th e m od el ca n b e u sed for cu rren t
stab ilization analysis.

GENERAL MONETARIST VIEW
T h e gen eral m o n etarist view is th at th e rate o f m o n ­
etary ex p an sio n is th e m ain d eterm in an t o f total
spen ding, co m m o n ly m easu red by gross n atio n al
p ro d u ct (GNP).’ C hanges in to tal sp end ing, in turn,
in flu en ce m ovem en ts in output, em p lo y m en t an d th e
gen eral p rice level. A b asic p rem ise o f this analysis is
th at th e eco n o m y is b asically stab le an d n o t n e c e s sa r­
ily su b je ct to recu rrin g p erio d s o f severe re ce s sio n an d
inflation. M ajor b u sin ess cy cle m ovem ents that have
o ccu rred in th e p ast are attrib u ted prim arily to large
sw ings in th e rate o f grow th in th e m o n ey stock.
T h is view regarding aggregate e c o n o m ic relatio n ­
sh ip s differs from prevailing view s w h ich co n sid e r

2General references on the monetarist view are Karl Brunner, "The
Role of Money and Monetary Policy,” this Review (July 1968), pp.
9-24; David I. Fand, “Some Issues in Monetary Economics,” this
Review (January 1970), pp. 10-27, and “A Monetarist Model of the
Monetary Process," forthcoming in the Journal of Finance.

46




OCTOBER 1986

aggressive p o licy a ctio n s n ece ssa ry to p ro m o te sta b il­
ity. M o n etarists gen erally h o ld th at fiscal a ctio n s, in
th e a b se n c e o f a cco m m o d ativ e m o n etary a ctio n s, ex ­
ert little n et in flu en ce on total sp en d in g an d th erefo re
have little in flu en ce on o u tp u t an d th e p rice level.
G overnm ent sp en d in g u n a c co m p a n ie d by a c c o m m o ­
dative m o n etary ex p an sio n , th a t is, fin a n ce d by taxes
o r b orrow ing from th e p u blic, re su lts in a crow d ing ou t o f private ex p en d itu res w ith little, if any, n e t in ­
crea se in total sp en d in g. A ch a n g e in th e m o n ey stock,
on th e o th e r h an d , ex erts a stron g in d e p en d e n t in ­
flu en ce on to tal sp en d in g. M o n etarists co n c lu d e th at
a ctio n s o f m o n e ta iy a u th o ritie s w h ic h re su lt in
ch a n g es in th e m o n ey sto ck sh o u ld b e th e m ain tool o f
e co n o m ic stabilization . S in ce th e eco n o m y is c o n sid ­
ered to b e basically stable, an d sin c e m o st m a jo r
b u sin ess cy cle m ov em en ts in th e p a st have resu lted
from in ap p ro p riate m ov em en ts in th e m o n ey stock,
co n tro l o f th e rate o f m o n etary e x p a n sio n is th e m e a n s
by w h ich e co n o m ic in stability ca n b e m in im ized .
T h e th eo retica l h eritage o f th e m o n eta rist p o sitio n
is th e qu an tity th eory o f m on ey.3 T h is th eo ry d ates
b ack to th e cla ssica l eco n o m ists (particularly David
Ricardo) in th e early 1800s. T h e q u an tity th eo ry in its
sim p lest form is ch a ra cte riz ed as a rela tio n sh ip b e ­
tw een th e sto ck o f m o n ey an d th e p rice level. C lassical
eco n o m ists co n c e n tra te d on th e lo n g -ru n a sp e cts of
th e qu an tity th eo ry in w h ich ch a n g es in th e m o n ey
sto ck resu lt in ch an g es o n ly in n o m in al m ag n itu d es,
like th e p rice level, b u t have n o in flu en ce o n real
m agn itu d es like ou tp u t an d em p loy m en t.
T h e qu an tity th eory o f m on ey in its m o d ern form
reco g n izes th e im p o rtan t in flu en ce th at ch a n g es in
th e m o n ey stock ca n have o n real m ag n itu d es in th e
sh o rt run, w hile in flu en cin g o n ly th e p rice level in th e
long run. T h e m o d ern qu an tity th eo ry p o stu la tes th at
in th e sh o rt run a ch a n g e in th e rate o f grow th in
m on ey is follow ed w ith a m o d erate lag by ch a n g es in
total sp en d in g an d output, w h ile ch a n g es in th e p rice
level follow w ith a so m ew h at lo n g er lag.4 T h e se

3The classic work on the quantity theory is Irving Fisher, The Pur­
chasing Power of Money (New York: Macmillan, 1911). For an
extensive review of the quantity theory literature, see Arthur W.
Marget, The Theory of Prices: A Re-examination of the Central Prob­
lems of Monetary Theory (New York: Prentice-Hall, 1938), volume II,
pp. 3-133.
“Many of the ideas prevalent in current monetarist doctrine can be
found in the writings of O ^ k Warburton in the 1940s and early
1950s. Many of his im p la n t articles have been reprinted in his
Depression, Inflation, and Monetary Policy, Selected Papers, 19451953 (Baltimore: The Johns Hopkins Press, 1966). See also Milton
Friedman (ed.), Studies in the Quantity Theory of Money (Chicago:
University of Chicago Press, 1958), and Lloyd W. Mints, Monetary
Policy in a Competitive Society (New York: McGraw-Hill, 1951).

OCTOBER 1986

FEDERAL RESERVE BANK OF ST. LOUIS

Exhibit 1

Model in Algebraic Form
(1) Total Spending Equation
AY, = f, (AM,... AM,_„, AE, - AE,^„)
(2) Price Equation
AP, = f2 (D,... D,_n, APA,)
(3) Demand Pressure Identity
D, = AY, - (XF, - X,_,)
(4) Total Spending Identity
AY, = AP, + AX,
(5) Interest Rate Equation
R, = f3 (AM,, AX,... AX,_„, AP,, AP*)
(6) Anticipated Price Equation
AP‘, = f4 ( A P ... AP
(7) Unemployment Rate Equation
U, = f5 (G„ G,_,)
(8) GNP Gap Identity
„ xf, -x,
G ,= x f,

AY, =
AP, =
D, =
AX, =
R, =
APA, =
U, =
G, =

Endogenous Variables
change in total spending
(nominal GNP)
change in price level (GNP price
deflator)
demand pressure
change in output (real GNP)
market interest rate
anticipated change in price level
unemployment rate
GNP gap

Exogenous Variables'
AM, = change in money stock
,AE, = change in high-employment
Federal expenditures
XF, = potential (full-employment)
output

'Other than lagged variables.
ch an g es in total spending, o u tp u t and p rice s are in
th e sam e d irectio n as th e ch an g e in th e rate o f m o n e­
taiy expansion .
T h e m o d ern qu an tity th eo ry still a cc e p ts th e longrun p o stu lates o f its o ld er version. A ch an g e in th e rate
o f m o n etary ex p an sio n in flu en ces only n o m in al m ag­
n itu d es in th e long run, nam ely, total sp en d in g (GNP)
an d th e p rice level. Real m agnitu d es, n otably output
a n d em ploym en t, are u n affected .3 Follow ing th e sh o rtrun re sp o n ses to a ch an g e in th e rate o f m o n eta iy
growth, total sp end ing an d th e p rice level grow at
rates d eterm in ed by th e rate o f in crea se in m oney,

5See Milton Friedman, “The Role of Monetary Policy,” American
Economic Review (March 1968), pp. 1-17.



w hile ou tp u t m oves tow ard an d resu m es a lon g-run
grow th path. Su ch grow th in o u tp u t is little in flu en ced
by th e rate o f m o n eta iy ex p a n sio n . In stead , it is d eter­
m in ed by grow th in th e e c o n o m y ’s prod uctive p o te n ­
tial, w h ich d ep en d s on grow th o f natu ral reso u rces,
cap ital stock, lab or force an d productivity.

GENERAL FORM O F TH E M ODEL
A sum m ary o f th e m o d el is p re sen ted in algebraic
form in exhibit 1, along w ith a listing o f variables
classified as to w h eth er th ey are en d o g en o u s or exo g e­
n o u s to th e m odel (for a g rap h ical illu stration o f the
m odel, see ap p en d ix B). T h is g en eral form o f the
m od el su m m arizes its essen tia l featu res, ignoring
pro b lem s o f d im en sio n ality an d lag length.

47

OCTOBER 1986

FEDERAL RESERVE BANK OF ST. LOUIS

Equations o f the Model
E qu atio n (1) is th e total sp en d in g eq u atio n . T h e
ch a n g e in to tal sp en d in g (AY) is sp ecified as a fu n ctio n
o f cu rren t and p ast ch an g es in th e m o n ey sto ck (AM)
an d cu rren t and past ch an g es in hig h -em p loy m ent
fed eral ex p en d itu res (AE). T h is general sp ecifica tio n
rep rese n ts th e re d u ce d form for th at cla ss o f s tru c ­
tu res w h ich h as AM and AE as exo g en o u s variables. In
th is form th e total sp en d in g eq u atio n rem ain s u n c o m ­
m itted as to stru ctu re; it is p o ten tially co n siste n t w ith
b o th K eynesian an d qu antity th eo ry m odels." (The
m agn itu d e an d sign ifican ce o f th e estim ated p ara m e­
ters d eterm in e w h eth er th e d ata co n fo rm m ore
clo sely to a K eynesian o r a qu antity theory.)
E qu ation (2) sp ecifies th e ch an g e in th e p rice level
(AP) as a fu n ctio n o f cu rre n t an d p a st d em an d p re s­
su res (D) an d an ticip ated p rice ch an g es (AP'). D em and
p ressu re is d efined in eq u atio n (3) as th e ch an g e in
total sp en d in g m inu s th e potential in crea se in ou tp u t
(X1 — X). T h e p rice eq u atio n is an alternative to th e
stand ard sh o rt-ru n Phillips cu iv e relatio n gen eralized
to in clu d e ch an g es in to tal sp en d in g an d a n ticip a te d
p rice s.7 (Set: append ix A for fu rth er d evelop m en t of
this relationship.)
E q u atio n (4) d efin es a ch an g e in to tal sp en d in g in
term s o f its co m p o n e n ts, th e p art asso cia te d w ith
ch a n g es in th e p rice level (AP) an d th e part asso cia ted
w ith ch an g es in o u tp u t (AX).” W ith AY d eterm in ed by
eq u atio n (1), and AP by eq u atio n (2), AX ca n b e derived
from eq u atio n (4).
E qu atio n (5) sp ecifies th e m arket rate o f in tere st (R)
as a fu n ctio n o f cu rren t ch an g es in th e m o n ey stock
(AM), cu rre n t an d p ast ch an g es in o u tp u t (AX), cu rren t
p rice ch a n g e (AP), an d a n ticip ate d p rice ch an g e (AP').
T h e p rice a n ticip atio n s term is in clu d ed to cap tu re
th e F ish er effect.9 T h e a n ticip ate d p rice fu n ctio n is

6For further discussion of the structural versus the reduced form of a
model, see Michael Keran, “Monetary and Fiscal Influences on
Economic Activity— The Historical Evidence,” this Review (Novem­
ber 1969), pp. 5-24; Edward M. Gramlich, “The Usefulness of
Monetary and Fiscal Policy as Discretionary Stabilization Tools,”
forthcoming in the Journal of Money, Credit, and Banking; and
Richard G. Davis, “How Much Does Money Matter? A Look at Some
Recent Evidence,” Federal Reserve Bank of New York Monthly
Review (June 1969), pp. 119-31.
7See Roger W. Spencer, “The Relation Between Prices and Employ­
ment: Two Views," this Review (March 1969), pp. 15-21.
8The change in the price level, AP, and the change in output, AX, are
defined in dollar units so that their sum is equal to the change in total
spending, AY.
9For a detailed study of interest rates and the Fisher effect, see
William P. Yohe and Denis S. Karnosky, “ Interest Rates and Price

48




defined in eq u atio n (6). A n ticip ated p rice ch a n g e (AP')
in th e cu rre n t p eriod is a ssu m ed to d ep e n d on p ast
p rice ch a n g es (AP).
E q u atio n (7) is th e u n em p lo y m en t rate eq u a tio n
a n d is a tran sfo rm atio n o f th e GNP gap (G), as d efin ed
in eq u atio n (8), in to a m e a su re o f u n e m p lo y m en t re la ­
tive to th e lab or force. T h is tran sfo rm atio n is b a se d on
“O ku n’s L aw .''1
0

Workings o f the Model
T h e w orkings o f th e m o d el are su m m arized by a
flow diagram (exhibit 2). O nly variables in th e cu rre n t
p erio d are sh o w n in th e diagram ; lagged variables,
w ith th e ex cep tio n o f p a st ch a n g es in p rice s, are
o m itted . T h e re la tio n sh ip th a t d e te rm in e s to tal
sp en d in g is th e fu n d am en tal o n e am o n g th o se th at
d eterm in e th e en d o g en o u s variables o f th e m od el.
T o tal sp en d in g is d eterm in ed by m o n eta ry a ctio n s
an d fiscal a ctio n s (federal sp en d in g fin a n ce d by taxes
o r b orrow ing from th e p u blic), th o u gh n o d ire ct in fo r­
m atio n is provided as to how su ch a ctio n s affect
spen din g.
T h e ch a n g e in to tal sp en d in g is co m b in ed w ith
p o ten tial (full em ploym ent) o u tp u t to provide a m e a ­
su re o f d em an d p ressu re. A n ticip ated p rice ch an ge,
w h ich d ep en d s on p ast p rice ch an g es, is co m b in ed
w ith d em an d p ressu re to d eterm in e th e ch a n g e in th e
p rice level.
T h e total sp en d in g id en tity en a b les th e ch a n g e in
output to be d eterm in ed , given th e ch a n g e in total
sp en d in g an d th e ch a n g e in p rices. T h is m eth o d o f
d eterm in in g th e ch a n g e in to tal sp en d in g a n d its
division b etw een o u tp u t ch a n g e an d p rice ch a n g e
differs from m o st e c o n o m e tric m o d els. A stan d ard
p ra c tice in ec o n o m e tric m o d el bu ild in g is to d e te r­
m ine o u tp u t an d p rice s sep arately, th e n co m b in e
th e m to d eterm in e total sp en d in g.
T h e ch a n g e in output, th e ch a n g e in p rices an d in
a n ticip a te d p rices, along w ith th e ch a n g e in th e
m o n ey stock, d eterm in e m arket in tere st ra tes. T h e
flow diagram show s th a t th e m arket in tere st rate d oes

Level Changes, 1952-69,” this Review (December 1969), pp. 1838.
'“Arthur M. Okun, “ Potential GNP: Its Measurement and Signifi­
cance,” 1962 Proceedings of the Business and Economic Statistics
Section of the American Statistical Association, pp. 98-104. Okun’s
Law relates the GNP gap to the unemployment rate as follows:
XF, - X, = .03(U, - 4)X,.
The number .03 is a productivity factor and 4 is defined as the
unemployment rate consistent with full resource utilization.

FEDERAL RESERVE BANK OF ST. LOUIS

OCTOBER 1986

Exhibit 2
Flow Diagram of Model

n o t ex e rcise a d irect role in th e m o d el in th e d eterm i­
n atio n o f spendin g, output, and p rices.
To d eterm in e th e u n em p loy m en t rate, th e ch an g e
in o utput is first co m b in ed w ith p o ten tial o u tp u t to
d eterm in e th e GNP gap relative to p o ten tial ou tp u t.
T h e GNP gap is th e n tran sfo rm ed in to th e u n em p lo y ­
m ent rate.

Summary
T h e m odel h as b ee n p resen ted in gen eral form to
sh ow th e b asic linkages p o stu lated am o n g m oney,
federal exp en d itu res, p rice s an d o u tp u t. T h e p u r­
pose o f th e follow ing statistical sectio n is to estim a te
th e re sp o n se o f o u tp u t an d p rice s to m o n eta iy an d



fiscal a ctio n s, n ot to test a h y p o th esized stru ctu re. T h e
focu s is on th e re sp o n se in th e sh ort run — period s of
tw o o r th ree y ears — b u t th e lon g -ru n p ro p erties o f
th e m odel also are exam in ed .

ESTIMATION O F TH E M ODEL
T h e gen eral form o f th e m od el in d ica tes th o se vari­
ables th at are in clu d ed in ea ch eq u atio n . E stim atio n
requires selectio n o f th e alg eb raic form o f the eq u a ­
tio n s an d th e te ch n iq u e s to b e u sed in estim ation .
E ach o f th e eq u atio n s o f th e m o d el is estim ated by
ord inary least squ ares. Lag stru ctu res, w ith o n e ex c e p ­
tion, are estim ated by th e Alm on lag te ch n iq u e . T h e
rep o rted relatio n sh ip s reflect co n sid era b le ex p eri­

49

FEDERAL RESERVE BANK OF ST. LOUIS
m en tatio n w ith th e n u m b er o f lags an d th e degree o f
th e p oly n om ial." T h e sam p le period starts w ith 1953
for th e sp end in g eq u atio n an d w ith 1955 for all the
o th ers. T h e d ata are qu arterly and, w ith th e ex cep tio n
o f in tere st rates, are season ally ad ju sted .
C riteria u sed in th e selectio n o f th e eq u atio n s w ere
m inim izin g th e stand ard erro r o f estim ate an d elim i­
natin g serial co rrelatio n in th e estim ated resid u als. In
ad d ition, th e signs and statistical sig n ifican ce o f the
estim ated co efficien ts received co n sid eratio n , along
w ith th e p attern o f th e lag d istribu tion . S in ce th e se
criteria frequ en tly co u ld n ot be satisfied sim u lta n e­
ously, an elem en t o f su bjectivity w as p re sen t in s e le c t­
ing th e “b e s t” eq uation.

Total Spending
T h e ch an g e in total sp en d in g is sp ecified as a fu n c­
tion o f cu rren t an d past ch an g es in th e m oney stock
(dem and d ep o sits and cu rre n cy h eld by th e n o n b an k
public) an d in h ig h -em p loy m ent F ed eral e x p e n d i­
tu res (exp end itu res on good s an d services p lu s tra n s­
fer pay m en ts a d ju sted to rem ove th e in flu en ce o f
variations in e co n o m ic activity on u n em p loy m en t
ben efit paym ents). T h e c h o ice o f th e p a rticu la r eq u a ­
tion (table 1) is b ased on previous w ork by A nd ersen
an d Jo rd a n .'2 Im p licit in th is c h o ice is th e a ssu m p tio n
th at th e ch an g e in th e m oney sto ck is an exo g en o u s
variable. A m o re co m p lete m odel w ould sp ecify a
m e ch an ism w h ereby th e m o n ey stock is d eterm in ed
by a ctio n s o f th e m o n etary au thorities, th e pu blic, an d
th e banking system .
T h e p attern o f th e co efficien ts in d icates a large an d
rapid in flu en ce o f m o n eta iy a ctio n s on to tal sp en d in g
relative to that o f fiscal a ctio n s.1 C hanges in high3
em p lo y m en t exp en d itu res, w ith th e m o n ey stock h eld
co n stan t, first have a posiuv'e in flu en ce on total sp en d -

"For discussion of the use and interpretation of the Almon lag
technique, see Keran, p. 10.
,2Leonall C. Andersen and Jerry L. Jordan, “Monetary and Fiscal
Actions: A Test of Their Relative Importance in Economic Stabiliza­
tion," this Review (November 1968), pp. 11-24. See also Keran, pp.
5-24.
l3Andersen and Jordan tried several measures of fiscal actions in
their basic equation. The best results were obtained by using only
high-employment expenditures, rather than the high-employment
surplus or both high-employment expenditures and receipts. They
justify their choice by appealing to the notion that financing expendi­
tures by borrowing from the public and taxes have essentially the
same impact on total GNP. For some results that contradict those of
Andersen and Jordan, see E. G. Corrigan, “The Measurement and
Relative Importance of Fiscal Policy,” forthcoming in Federal Re­
serve Bank of New York Monthly Review. It should be repeated that,
a priori, specification of the total spending equation was sufficiently
general as to be consistent with a number of theories of GNP
determination.

50




OCTOBER 1986

Table 1
Total Spending Equation
Sample Period: I/1953-IV/1969
Constraints: 4th Degree Polynomial
(m_, = e_, = 0; m5 = e6 = 0)

=2.67 + 2 m.AM,., + 2 e^Et-i
(3.46) i = 0
i= 0
m0 = 1.22
m, = 1.80
m2 — 1.62
m3 = .87
m4 = .06
2m; = 5.57

(2.73)
(7.34)
(4.25)
(3.65)
( 12)
(8.06)

R2 = .66
SE = 3.84
DW = 1.75

e0 = .56 ( 2.57)
e, = .45 ( 3.43)
62 ~ .01 ( .08)
®3 = -.4 3 ( -3.18)
e* = -.5 4 ( - 2.47)
Se, = .05 ( .17)

Symbols are defined as:
AY, = dollar change in total spending (GNP in current prices)
in quarter t
AM,_i = dollar change in money stock in quarter t - i
AEt_, = dollar change in high-employment federal expendi­
tures in quarter t - i
NOTE: “t” statistics appear with each regression coefficient,
enclosed by parentheses. R2 is the percent of variation in
the dependent variable which is explained by variations in
the independent variables. SE is the standard error of the
estimate. DW is the Durbin-Watson statistic.
ing, bu t th e in flu en ce b e c o m e s sign ifican tly negative
after th ree qu arters. F isca l actio n s, u n a c co m p a n ie d by
ch a n g es in m oney, have little n et effect o n GNP over
five q u a rters.1 F o r sh o rt p eriod s, an d for ex ten d ed
4
period s in w h ich th e rate o f ch a n g e o f fed eral ex p e n d ­
itu res is eith e r a ccelera tin g o r d eceleratin g , fiscal ef­
fects are significant. T h e estim a ted co e fficie n ts for
ch a n g es in m o n ey an d ch a n g es in fed eral e x p e n d i­
tu res are in g en eral ag reem en t w ith th e m o n eta rist
view o f th e re sp o n se o f to tal sp en d in g to th e se two
variables.
T h e sp ecifica tio n o f the total sp en d in g eq u atio n , as
sh ow n in table 1, has b een criticiz ed as b ein g in c o m ­
plete in th at it allegedly ig n ores th e effects o f in tere st
rates o n v elo city .1 However, sin c e th e sp e n d in g eq u a ­
5

l4Andersen and Jordan, p. 18, indicate that these results are consist­
ent with a “crowding-out” theory of effects of government spending.
15See Paul S. Anderson, “Monetary Velocity in Empirical Analysis,” in
Controlling Monetary Aggregates, Proceedings of the Monetary
Conference held on Nantucket Island (June 1969), pp. 37-51, and
the discussion of that paper by Leonall C. Andersen, pp. 52-55. See
also Henry A. Latane, “A Note on Monetary Policy, Interest Rates
and Income Velocity,” Southern Economic Journal (January 1970),
pp. 328-30.

FEDERAL RESERVE BANK OF ST. LOUIS
tion is a red u ced form , su ch effects ait; em b od ied in
th e coefficien ts o f m o n ey ."1

Total Spending Equation
T h e total sp en d in g eq u atio n is th e co rn e rsto n e o f
the m odel, providing its m o n etarist ch a ra cte r. T h e
focu s o f this paper, how ever, is on d eterm in in g th e
division o f th e ch an g e in total sp en d in g b etw ee n p rice
an d ou tp u t ch an g es. P rice ch an g es are estim ated as a
fu n ctio n o f (1) cu rre n t and p ast d em an d p ressu re, an d
(2) an ticip ated p rice ch an g e.
D e m a n d p r e s s u r e — As a m e asu re o f d em an d p re s­
su re on p rices, th e ch an g e in total sp en d in g is related
to th e potential ch an g e in o u tp u t (GNP in co n sta n t
p rice s).1 T h e se tw o variables, w h en co m b in ed , p ro ­
7
vide a m easu re o f th e eco n o m y 's d em an d for goods
an d services relative to its cap acity to su pply goods
an d services. T h e ch an g e in p rices is sp ecified as a
positively related lin ear fu n ctio n o f th is m easu re o f
d em an d p ressu re (see ap p en d ix A).
D em and p ressu re, D„ is defined as:
D, = AY, - (X1, - X,_,),
w h ere AY, is th e ch an g e in total sp en d in g in q u arter t;
XK is p o ten tial (full em ploym ent) GNP in 1958 p rice s in
,
q u a rter t; an d X,_, is real GNP in th e previous quarter."*
Given th e GNP gap, d efined as X1, — X,_,, th e larger is
th e ch an g e in total sp en d in g (AY,), th e g reater is th e
spillover into h ig h er p rices. Given AY„ th e larger is
X', — X, _ „ the greater is th e ex p an sio n o f o u tp u t and
th e less th e spillover into h ig h er p rices.
In ad d itio n to cu rre n t values, p ast values o f th e
d em an d p ressu re variable are in clu d ed in th e p rice
eq u ation . T h e p u rp o se o f in clu d in g p ast values is to
allow for lags in th e d eterm in atio n o f p rices in re ­

16See A. A. Walters, “Monetary Multipliers in the U. K.: 1880-1962,”
Oxford Economic Papers (November 1966).
"This measure was apparently first used by Ray Fair of Princeton
University. See his “The Determination of Aggregate Price
Changes,” forthcoming in the Journal of Political Economy. For a
similar specification of a price equation, see Milton Friedman, “A
Theoretical Framework for Monetary Analysis,” also forthcoming in
the Journal of Political Economy. See also a paper by William
Considine of Stanford University, “Public Policy and the Current
Inflation,” prepared as a part of a summer intern program at the U.S.
Treasury Department (September 5,1969).
18The series on potential output is based on that used by the Council
of Economic Advisers. Currently, potential output is estimated to be
rising at a 4.3 percent annual rate. For alternative estimates of
potential output, see Fair, “The Determination of Aggregate Price
Changes.”



OCTOBER 1986
sp o n se to ch an g in g d em an d . F u rth erm o re, th e im p act
of ch an g in g d em an d th rou gh ch an g in g in p u t p rices
an d co sts o f p ro d u ctio n is given a c h a n c e to o p erate
by in clu d in g lagged values for th e d em a n d p ressu re
variable.
A nticip ated p r ic e c h a n g e — T h e o th e r in d e p en d e n t
variable in clu d ed in th e p rice eq u atio n is a m easu re o f
a n ticip a te d p rice ch an g e (AP\). T h e p u rp o se o f in ­
clu d in g th is variable as a fa cto r in flu en cin g cu rren t
ch a n g es in th e p rice level is to allow a n ticip a tio n s o f
future p rice m ovem en ts to in flu en ce th e d ecisio n s o f
m arket p articip an ts. Sin ce su ch a variable is n o t o b ­
servable, it h a s to b e co n stru c te d . T h is is a c c o m ­
p lish ed by assu m in g th at a n ticip a tio n s abou t future
p rice ch a n g es are form ed on th e b asis o f p ast p rice
ex p erien ce.
T h e m easu re o f p rice a n ticip a tio n s u sed in th is
stud y is a b y -p rod u ct o f estim atin g lon g-term m arket
in terest ra te s.11Yohe an d K arnosky sh o w ed th a t lon g­
5
term m arket in terest rates resp o n d to p rice a n ticip a ­
tio n s o f borrow ers an d len d ers, sin ce co m m itm e n ts to
borrow an d len d fu n d s requ ire an a sse ssm en t o f a n tic ­
ip ated ch a n g es in th e p rice level for th e p eriod o f the
loan . T h e p rob lem co n sists o f isolatin g this p rice effect
on m arket in terest ra tes from facto rs in flu en cin g th e
real rate.
In the p ro cess o f co n stru ctin g a m e a su re o f a n tici­
pated p rice ch an g e, past ch a n g es in p rices are a d ­
ju sted by a su m m ary m easu re o f cu rre n t e co n o m ic
co n d itio n s. Sin ce p rice ch a n g es ten d to lag ch a n g es in
total spending, th e degree o f re so u rce u tilization as
m easu red by th e u n em p lo y m en t rate is u sed as a
lead in g in d ica to r o f future p rice m ov em en ts.20 F or
exam ple, if u n em p lo y m en t is rising relative to the
lab or force, d ecisio n -m ak in g e co n o m ic u n its w ould
ten d to d isco u n t cu rren t inflation in form ing a n ticip a ­
tion s about future p rice m ovem en ts. R eflecting this
co n sid eratio n , th e p rice ch a n g e in e a c h q u a rter is
divided by an ind ex o f th e u n em p lo y m en t rate ap p li­
cab le to that quarter. T h u s th e m ea su re o f p rice a n tici­
p atio n s w ould b e less for a given inflation rate a c c o m ­
p an ied by high o r risin g u n em p lo y m en t th an w h en
u n em p loy m en t is low o r falling.
T h e sp ecific defin ition o f p rice a n ticip a tio n s is
sh o w n in table 2. T h e w eights and th e len gth o f th e lag

'9For other ways of handling expectations, see appendix C on alterna­
tive price equations.
“ For purposes of exposition the unemployment rate was not included
in the definition of anticipated price change in exhibits 1 and 2.

51

FEDERAL RESERVE BANK OF ST. LOUIS

OCTOBER 1986

Table 2

Table 3

Anticipated Price Definition

Price Equation
Sample Period: 1/1955—
IV/1969
Constraints: 2nd Degree Polynomial
(d_, * 0;d6 = 0)
5
AP, = 2.70 + 2 d,D,_, + .86APA,
(7.07) i = 0
(8.55)

(Pi from Long-Term Interest Rate Equation)
APA, = Y,-2{ [ ( 17 ..P ) .01 + 1]'/4 - 1}
2
i=1 U' i/4
P ,

=
p2 =
p3 =
P4 =
P5 =
Pe =
Pi

.02
.03
.04
.06
.06
.07

p7 = .08
p8 = 08
p9 = .08
PlO ~ -OS
= 08
P12 = -07
P it

=
Pl4 =
P,5 =
P .6 =
P,7 =
2p, =
P l3

.06
.06
.04
.03
.02
.96

Symbols are defined as:
APA = anticipated price change (scaled in dollar units) in
t
quarter t
Pt_, = annual rate of change in GNP deflator (1958 = 100) in
quarter t - i
Ut_,/4 = index of unemployment as a percent of labor force
(base = 4.0) in quarter t - i
Y,_2 = total spending (GNP in current prices) in quarter t - 2

perio d w ere o btain ed from th e estim ated long-term
in terest rate eq u atio n .-1
E stim a ted p r ic e eq u a tio n — T h e estim ated p rice
eq u ation is show n in table 3, w here AP, is defin ed as
th e d o llar ch an g e in total sp en d in g d ue to p rice
ch a n g es in q u arter t. T h e in flu en ce on p rice s o f th e
d em an d p ressu re variable, D , i s significant and p o si­
tive for five qu arters but very sm all th e re a fte r.- T h e
p a ttern o f in flu en ce is o n e o f stead y d ecay, w ith 70
p e rce n t o f th e total effect o f d em an d p ressu re taking
p la ce in th e first th ree qu arters an d 95 p e rce n t in th e
first five qu arters.
A nticipated p rice change, rep rese n te d by APA is a
„
sign ificant d eterm in an t o f cu rre n t p rice ch an g e.
T h ou g h significant, th e m easu re o f th e im p act o f this
variable sh o u ld n o t be tak en too literally, b e c a u se its
co n stru ctio n in d icates th at it ca n n o t really b e view ed

21The price expectations variable as shown in table 2 is scaled in
dollar units. This transformation is made because prices are esti­
mated as the dollar change in total spending due to price changes.
“ When the price equation is estimated with the components of D,_i
separated, the coefficients for the AY, portion are not statistically
significant at the five percent level, implying that the gap portion
(XF, - X,_,), explains most of the changes in AP,. However, there
may be collinearity problems which influence the estimated coeffi­
cients. Furthermore, the D,_i form is used because, theoretically, it is
a measure of excess demand (see appendix A).

52




d0 =
d, =
d2 =
d3 =

.02 (2.63)
.02 (6.33)
.02 (6.63)
.01 (2.93)

R2 = .87
SE = 1.07
DW = 1.41
d„ = .01 (1.86)
d5 = * (1.38)
2d, = .09 (9.18)

Symbols are defined as:
AP, = dollar change in total spending (GNP in current prices)
due to price change in quarter t
D, = AY, - (XF, - X,.,)
AY, = dollar change in total spending (GNP in current prices)
in quarter t
XF, = potential output in quarter t
X,_, = output (GNP in 1958 prices) in quarter t - 1
APA, = anticipated price change (scaled in dollar units) in
quarter t
NOTE: "t” statistics appear with each regression coefficient,
enclosed by parentheses. R2 is the percent of variation in
the dependent variable which is explained by variations in
the independent variables. SE is the standard error of the
estimate. DW is the Durbin-Watson statistic.
*Less than .01

in d ep en d en tly o f th e d em a n d p re ssu re variable.-1T h e
in flu en ce o f th e se tw o variables sh o u ld p e rh a p s be
view ed in co m b in atio n , ra th er th a n as in d e p en d e n t
an d sep a ra te in flu en ces.2
4
D eterm ina tion o f o u tp u t — Given AY, as d eter­
m in ed by th e to tal sp en d in g eq u atio n , an d AP, from
th e p rice eq u atio n , th e d ollar ch a n g e in to tal sp en d in g
d ue to o u tp u t ch an g es, d efin ed as AX„ ca n b e derived

ziFrom the standpoint of the model as a unit, price anticipations are
important only in determining the division of total spending between
prices and output, not the level (or change) of spending itself. To
allow for the possible direct influence of price expectations on total
spending, the spending equation was estimated with the price
anticipations variable. The coefficient of the price anticipations
variable was not significant for this specification.
24There is, however, some evidence that the price anticipations vari­
able may be interpreted as an independent and separate influence.
When the price equation is estimated without APA„ the sum of the
coefficients on D,_, is only slightly more than shown in table 3 and the
standard error is increased considerably.

FEDERAL RESERVE BANK OF ST. LOUIS

OCTOBER 1986

from th e follow ing identity:
AY, = AP, + AX, + (P, - P,_,) ( X, - X,_,).
T h e cro ss-p ro d u ct term is a ssu m ed equal to zero.-'
Thus,

AX, = AY, - AP,.
T h e u nem p loy m en t rate plays a role in th e m odel,
rep resen tin g th e m ean s by w h ich p ast p rices are a d ­
ju sted to take in to a cc o u n t varying e c o n o m ic c o n d i­
tion s in th e form ation o f an ticip ated p rice ch an g es. To
estim ate th e u nem p loy m en t rate, th e u nem p lo y m en t
rate is regressed on cu rre n t an d lagged values o f th e
GNP gap, exp ressed as a p e rce n t o f p o ten tial GNP. T h is
eq u atio n is estim ated by u n co n stra in ed ord inary least
squ ares and is show n in table 4.

Interest Rates
In terest rates do n o t fu n ctio n exp licitly in th e m odel
as a p art o f a tran sm issio n m e ch a n ism ru n n in g from
ch a n g es in th e m o n ey sto ck to o u tp u t an d p rices. T h e
estim ated long-term in tere st rate eq u atio n plays a vital
role in th e m odel, how ever, providing th e in form ation
to ca lcu late th e m easu re o f p rice an ticip atio n s.
M arket in terest rates are sp ecified to d ep en d on
cu rren t and p ast rates o f ch a n ge o f o u tp u t (X), th e
cu rren t rate o f ch an g e in th e m o n ey sto ck (M), and
cu rren t and past rates o f ch an g e in p rices (P) a d ju sted
by an in d ex o f th e u nem p lo y m en t rate. T h is sp e cifica ­
tion draw s on Sarg ent's work, w h ich w as exp lored
fu rth er by Yohe and Karnosky.2
"
L o n g -term in terest ra te — T h e lon g -term m arket
rate (R1,) is m easu red by th e rate on sea so n e d c o rp o ­
rate Aaa bo n d s. C han ges in o u tp u t an d p rice s (ad­
ju sted for u nem ploym ent) lagged for 17 q u arters p ro ­
vide th e m o st satisfactory resu lts. T h e estim ated
eq u ation for th e lo n g -term rate is show n in table 5.

25The value of this cross-product term was calculated from 1953 to the
present and provides ample justification for the assumption that it be
equated to zero for purposes of the model here. Also note that AP, is
defined in dollar units, that is, as (P, - P,_,)X,_,, not (P, - P,_,). AX,
is defined analogously.
^Thomas Sargent, “Commodity Price Expectations and the Interest
Rate,” Quarterly Journal of Economics (February 1969), pp. 127-40,
and Yohe and Karnosky, pp. 31-34, 38. The estimated interest rate
equations also contain a dummy variable (0 for 1955-60 and 1 for
1961-69). The significance of this dummy variable indicates a shift
of structure within the sample period. Questions can be raised about
this procedure, but it is felt that a price expectations variable should
not be constructed on the basis of a sample period containing only
an expansion like 1961-69. Including the dummy variable leaves
unexplained that factor (or factors) which changed the relationship,
but it does provide a way of estimating a set of coefficients on prices
that is based on a sample period reflecting varying economic cir­
cumstances.



Table 4
Unemployment Rate Equation
Sample Period: I/1955-IV/1969_________

U, = 3.90 + .04G, + .28G,_,
(72.50) (1.10) (6.80)

R2 = .92
SE = .30
DW = .60

Symbols are defined as:
U, = unemployment as a percent of labor force in quarter t
XF, = potential output in quarter t
X, = output (GNP in 1958 prices) in quarter t
NOTE: “t” statistics appear with each regression coefficient,
enclosed by parentheses. R2 is the percent of variation in
the dependent variable which is explained by variations in
the independent variables. SE is the standard error of the
estimate. DW is the Durbin-Watson statistic.
T h e resu lts reflect, in a gen eral way, th e view
stresse d by m o n eta rists th at a ch a n g e in th e rate of
m o n eta iy ex p a n sio n in flu en ces m arket in tere st rates
in th ree stages.27 First, th e liquid ity effect o f a n in crea se
in th e rate o f ch a n g e o f th e m o n ey stock on m arket
in terest rates is negative. Seco n d , an in cre a s e in th e
rate o f m o n eta iy ex p a n sio n in flu en ces th e rate o f
ch a n g e in output, w h ich in tu rn h a s a positive in ­
flu en ce on m arket in terest rates. Finally, an in cre a s e in
m o n ey grow th in flu en ces th e rate o f ch a n g e in p rices,
w h ich h as a positive effect on m arket in tere st rates.
S h o rt-term in terest ra te — The sh o rt-term in terest
rate (Rs,) w h ich is estim a ted is th e fou r- to six-m o n th
co m m ercia l p ap er rate. T h e eq u atio n is sh o w n in
table 6. Price ch a n g es are fou nd to e n te r significantly
for a sh o rte r lag perio d th a n in th e lo n g -term rate
eq u atio n . Also, th e sh o rt-term rate, as m easu red by th e
fou r- to six-m o n th co m m e rcia l p a p e r rate, is m u ch
m o re sensitive to ch a n g es in o u tp u t an d th e m o n ey
stock th a n is th e long-term rate as m easu red by th e
rate on sea so n ed co rp o ra te Aaa b o n d s.

Time Response to Monetary Actions:
A Summary
T h e p attern o f th e co efficien ts in th e eq u atio n s
provides in form ation abou t th e tim e re sp o n se o f total
spen din g, output, an d p rices to m o n eta iy an d fiscal
actio n s. T h e eq u atio n s in d ica te th at m o n e ta iy a ctio n s

27See Friedman, “The Role of Monetary Policy,” p. 6.

53

FEDERAL RESERVE BANK OF ST. LOUIS
g en erally affect total sp en d in g w ith a tw o- to th reeq u a rte r lag. A ch an g e in th e rate o f grow th o f total
sp en d in g is acco m p a n ie d by a sim u ltan eo u s ch an g e
in th e rate o f grow th o f output, and it is not until th ree
qu arters la te r th at th e re sp o n se o f p rice s to a ch an g e
in d em an d p re ssu re bu ild s to 70 p e rce n t o f th e total.
T h e re sp o n se o f p rice s to a ch an g e in to tal sp en d in g is
y et slow er w h en th e re are a n ticip a tio n s o f a high rate
o f inflation.
T h e sp en d in g eq u atio n (table 1) in d icates that
ab o u t h a lf o f th e to tal re sp o n se to a ch a n g e in m o n e ­
tary grow th o cc u rs in th e first tw o qu arters, an d about
80 p e rce n t in th e first th ree qu arters.
T h e p atte rn o f co efficien ts in th e p rice eq u atio n
(table 3) in d icates th at th e effect o f a ch an g e in total
sp en d in g is reflected first in o u tp u t an d la ter in p rices.
O perating throu gh th e d em an d p ressu re variable,
a b o u t a fou rth o f th e re sp o n se o f p rices to a ch an g e in
to tal sp en d in g is in th e first qu arter, w h ich is about
tw o qu arters after th e ch an g e in m o n etary actio n s.
Over 70 p e rce n t o f th e p rice re sp o n se is in th e first
th ree qu arters, and 95 p e rce n t in the first five qu arters.
T h e re sp o n se o f th e p rice level to ch an g es in total
sp en d in g is also in flu en ced by a n ticip a te d p rices. T h e
g reater th e a n ticip ate d rise in p rices, th e longer d e ­
layed is th e re sp o n se o f th e p rice level to a d eclin e in
th e rate o f ch an g e in total spending.

TESTS OF THE M O D E L’S
PERFORMANCE
T h e eq u atio n s o f th e m o d el are to b e view ed as a
unit, an d th e sp ecificatio n o f th e m odel is su ch that
given th e ch an g e in m o n ey (AM), an d th e ch an g e in
h ig h -em p loy m en t ex p en d itu res (AE), th e m o d el can
be solved in th e follow ing seq u e n ce: for th e ch an g e in
total sp en d in g (AY), th e ch an g e in th e p rice level (AP),
th e ch an g e in real ou tp u t (AX), th e u nem p loy m en t rate
(U) an d th e long- an d sh o rt-term in tere st rates (RLand
Rs).
T h e exp lanatory p o w er o f ea ch o f th e eq u atio n s
sh o w n in tables 1 - 6 m ay be a cc e p ta b le by co n v en ­
tion al stand ard s, but th is provides no g u aran tee th at
th e m o d el w ill perform satisfactorily as a u nit. T h ere
are in terd e p en d e n cie s in th e m od el th at have to be
tak en in to a cc o u n t w h en evaluating th e co m p lete
m od el. O f in terest in evaluating th e m od el as a u n it is
the im plied pattern for th e en d o g en o u s variables
w h en only an initial set o f lagged en d o g en o u s vari­
ables and th e tim e path s o f th e exo g en o u s policy
variables (m oney sto ck an d h ig h -em p loy m ent federal

54




OCTOBER 1986

Table 5
Long-Term Interest Rate Equation
Sample Period: 1/1955-IV/1969
Constraints: 2nd Degree Polynomial
(x_, ^ 0, p_, =£ 0; x17 = p17 = 0)

RL, = 1.28 - .06M, + 1.42Z,
(5.20) (-3.53) (11.01)

16

16

+ 2 x, X,_, + X

i= 0

i= 0

p( (U,_/4)
rP^
r,-i
R2 = .92
SE = .28
DW = .69

Xo = .02 ( 3.85)
x, = .02 ( 4.35)
x2 = .02 ( 4.44)
x3 = .02 ( 4.08)
x„ = .02 ( 3.54)
x5 = .02 ( 3.03)

x6
x7
xs
x9
x,o
x„

=
=
=
=
=
=

.01 ( 2.61)
.01 ( 2.27)
.01 ( 2.01)
.01 ( 1.80)
.01 ( 1.64)
.01 ( 1.50)

x,2 =
x,3 =
x,4 =
Xi5 =
x,6 =
2x, =

p0 = .02 ( 1.23)
p, = .03 ( 3.05)
p2 = .04 ( 5.96)
p3 = .06 (10.82)
p4 = .06 (17.34)
p5 = .07 (19.66)

p6
p7
p8
p9
p,„
p„

=
=
=
=
=
=

.08 (17.13)
.08 (14.49)
.08 (12.64)
.08 (11.37)
.08 (10.47)
.07 ( 9.81)

p12 = .06 ( 9.29)
Pi3 = .06 ( 8.89)
p,4 = .04 ( 8.57)
p,5 = .03 ( 8.30)
Pi6 = 02 ( 8.07)
2p( = .96 (19.04)

.01 ( 1.38)
.01 ( 1.28)
* ( 1.20)
* ( 1.13)
* ( 1.07)
.20 ( 2.88)

Symbols are defined as:
RL, = Moody’s seasoned corporate Aaa bond rate in
quarter t
M, = annual rate of change in money slock in quarter t
Z, = dummy variable in quarter t (0 for 1/1955-IV/1960 and
1 for 1/1961 —
IV/1969)
X,_i = annual rate of change in output (GNP in 1958 prices)
in quarter t - i
Pt_( = annual rate of change in GNP deflator (1958 = 100) in
quarter t - i
U,_j/4 = index of unemployment as a percent of labor force
(base = 4.0) in quarter t - i
NOTE: “t” statistics appear with each regression coefficient,
enclosed by parentheses. R2is the percent of variation in
the dependent variable which is explained by variations in
the independent variables. SE is the standard error of the
estimate. DW is the Durbin-Watson statistic.
"Less than .01
expen d itu res) are a ssu m ed know n. T o co n d u ct su c h a
test, several d yn am ic sim u lation ex p e rim e n ts w ere
p erform ed . T h e se sim u lation s take th e form o f e * post
d yn am ic sim u lation s an d an epc ante d yn am ic sim u la ­
tion .3
*

28For a discussion of the different ways of assessing the tracking
ability of econometric models, see Carl F. Christ, “Econometric
Models of the Financial Sector,” forthcoming in the Journal of
Money, Credit, and Banking. For a discussion of simulation proce­
dures and results with an income-expenditure model, see Evans
and Klein, pp. 50-69.

FEDERAL RESERVE BANK OF ST. LOUIS

OCTOBER 1986

Table 6
Short-Term Interest Rate Equation
Sample Period: 1/1955—
IV/1969_________

Constraints: 2nd Degree Polynomial
(x_, 4 0, p., * 0; x„ = p„ = 0)
10
10
p
Rst = —1.13 - 17M, + .92Z, + 2 x, X,_, + 2 p,(— — )
(-3.14) (-6.36) (5.03) i = 0
i = 0 U'-’/4
R2 = .90
SE = .47
DW = .69
Xo =
x, =
x2 =
x3 =
x„ =
x5 =
x6 =
x7 =
x8 =
x9 =
x,0 =
Zx, =

.08
.08
.08
.08
.08
.07
.07
.06
.05
.03
.02
.71

( 8.10)
( 8.99)
( 8.97)
( 8.45)
( 7.83)
( 7.25)
( 6.76)
( 6.36)
( 6.02)
( 5.75)
( 5.52)
( 8.24)

Po =’
Pi =
P2 =
P3 =
P4
=
Ps =
Pe =
Pz =
Ps =
P9 =
Pio ”
SPi =

-.0 4
.04
.09
.14
.17
.18
.19
.18
.15
.11
.06
1.27

(-.9 1)
( 1.53)
( 8.26)
(18.52)
(13.17)
(10.29)
( 8.92)
( 8.14)
( 7.64)
( 7.30)
( 7.04)
(16.89)

Symbols are defined as:
Rs, = four- to six-month commercial paper rate in quarter t
M, = annual rate of change in money stock in quarter t
Z, = dummy variable in quarter t(0 for 1/1955-IV/1960 and
1 for 1/1961-I V/1969)
X,_i = annual rate of change in output (GNP in 1958 prices)
in quarter t - i
P,_i = annual rate of change in GNP deflator (1958 = 100) in
quarter t - i
U,_i/4 = index of unemployment as a percent of labor force
(base = 4.0) in quarter t - i
NOTE: “t” statistics appear with each regression coefficient,
enclosed by parentheses. R2 is the percent of variation in
the dependent variable which is explained by variations in
the independent variables. SE is the standard error of the
estimate. DW is the Durbin-Watson statistic.

Ex Post Dynamic Simulations
An e\ post d ynam ic sim u lation is co n fin ed to the
sam ple period from w h ich th e estim ated relatio n sh ip s
are derived. A ctual values for all cu rren t an d lagged
exog en ou s variables are u sed , bu t only initial actu al
values for th e lagged en d o g en o u s variables are used.
T h e m od el g en erates so lu tio n values for th e en d o g e­
n o u s variables in th e first sim u lation period, w h ich are
th en u sed to g en erate so lu tio n values for th e se co n d



period, and so on for e a c h su cce ed in g p erio d .-’ A
co m p ariso n o f th e se ca lcu la ted tim e p ath s for the
en d o g en o u s variables w ith th e ir a ctu al tim e paths
en ab les o n e to form ulate so m e ju d g m en t as to h ow
w ell th e m od el perform s as an in terd e p en d e n t unit in
tracking th e m ovem ents o f ce rta in strategic e co n o m ic
variables.
/> post d ynam ic sim u lation s w ere co n d u cte d for
■■
several su b p erio d s w ithin th e sam p le period (1 9 5 5 69). T h e resu lts for th e en tire sam p le perio d are su m ­
m arized in ch art 1 on th e next page. W hen sim u la­
tion s are c o n d u cte d for su b p erio d s w ithin th e 1 9 5 5 -6 9
period, th e p attern o f m ovem en t as sh o w n for th e
w h o le p eriod sim u lation te n d s to hold, b u t th e levels
are c lo se r to th e actual values at th e b egin n in g o f ea ch
su bperiod.
C hart 1 in d icates th at th e m od el ten d s to track the
m ovem ent o f th e en d o g en o u s variables qu ite w ell d u r­
ing th e 1 9 5 5 -6 9 period. Sin ce criteria for jud ging th e
p erfo rm an ce o f the m odel in su ch a sim u lation have
n o t b ee n developed, an y co n c lu sio n s are n ecessa rily
su bjective.3 T h e te n d en cy for th e m od el to avoid d i­
0
verging sharply from th e a ctu al p ath for ex ten d ed
period s is an esp ecially im p o rtan t featu re. Su ch a
featu re provides so m e b asis for tru stin g th e tracking
ability o f th e m o d el over several qu arters, even if o n a
qu arter-b y-qu arter b asis it m ay ap p e a r to b e off th e
mark.
To gain ad d ition al in form ation ab o u t th e pred ictive
p erfo rm an ce o f th e m odel, a co m p a riso n is m ad e w ith
an e?t post sim u lation from a n o th e r m od el. R esu lts of
an e * post sim u lation for 1963 an d 1964 have b een
p u b lish ed for th e W harton m od el. T h e resu lts for th e
m od el are co m p a red w ith th o se o f th e W h arton m od el
in table 7.
T h e period 1 9 6 3 -6 4 in clu d es th e 1964 tax cut,
w h ich , a cco rd in g to the W h arton m odel, is co n sid ered
an im p o rtan t fa cto r in flu en cin g e c o n o m ic d evelop­
m en ts in 1964. However, th e St. Louis m od el, w h ich
d o es n ot em p h asize su ch fiscal actio n s, did ab o u t as
well, on average, for th e y ea rs 1963 an d 1964 (see table
7). T h e m ain d ifference to b e rem em b ered in evaluat­
ing th e se sim u lation s is th at th e St. Louis m o d el c o n ­
tain s th ree prim ary exo g en o u s variables, w hile th e
W h arton m od el co n ta in s 43.

^See de Leeuw and Gramlich, “The Channels of Monetary Policy
. . . p. 485.
“ See Robert H. Rasche and Harold T. Shapiro, “The F.R.B.-M.I.T.
Econometric Model: Its Special Features,” American Economic Re­
view, Papers and Proceedings (May 1968), p. 142.

55

OCTOBER 1986

FEDERAL RESERVE BANK OF ST. LOUIS

C h a rt I

Results of Ex Post Dynamic Simulation
A n n u a l R a te s o f C h a n g e

1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969
N o t e : P r e d ic t e d v a lu e s b a s e d o n e s t im a t e o f m o d e l f o r s a m p le p e r i o d e n d in g I V / 1 9 6 9 .

56




FEDERAL RESERVE BANK OF ST. LOUIS

OCTOBER 1986

Table 7
Alternative Ex Post Simulations: Actual Minus Predicted1
Comparison of Wharton and St. Louis Models for 1963-64______
Nominal GNP2
Real GNP
Price Level3 Unemployment Rate4
Wharton St. Louis Wharton St. Louis Wharton St. Louis Wharton St. Louis
0.4
-0 .4
-3 .9
-0.1
0.2
1963: I
-4 .6
0.9
0.3
0.4 -0 .7
-0.1
II
-0 .2
0.3
0.2
0.7
0.1
2.5
0.6
-0 .3
0.1
III
1.3
1.5
0.9
-0.1
2.2 -0 .4
-0.2
2.1
0.5
1.2
IV
0.9
0.2
-1 .4
1.7
2.7
1.4
1964: I
0.9
-0 .3
0.6
0.2
3.2
2.3
-0 .3
1.4
II
1.1
0.1
0.6
0.2
4.0 -2 .7
1.7
-0 .5
0.8
III
1.5
1.6
0.2
2.2 -6 .8
-0.4
-1 .7
0.9
1.2
0.2
IV
0
1.55 -1.88 -0.28 0.49
0.11
0.76
1.16
0.16
Average Error
Root Mean
2.92
3.09
0.33 0.60
1.49
1.28
0.21
Squared Error 2.00

'Sample period:
Exogenous variables:
Wharton: 1948-1964
Wharton: 43
St. Louis: 1955-1969
St. Louis:
3
2Billions of dollars.
3Computed from the level of implicit price deflator.
“Percent.
Sources: M. K. Evans and L. R. Klein, The Wharton Econometric Forecasting Model, 2nd, Enlarged
Edition (Philadelphia: University of Pennsylvania, 1968); and Federal Reserve Bank of St.
Louis.

T h e co m p ariso n is n ot m ean t to im ply th at th e St.
Louis m od el is su p erior. R ather, th e su ggestion is
offered th at a sm all m o d el c o n stru c te d w ith in a m o n e ­
tarist fram ew ork m ay y ield as m u ch in form ation abou t
th e key aggregates as a large stru ctu ral m od el. In
sum m ary, sm all m o n etarist m o d els m ay b e u sefu l as a
guide in th e form u lation o f stabilizatio n policy.

Ep Ante Dynamic Simulations
An e?c ante d yn am ic sim u lation is like an e\ post
d ynam ic sim ulation , excep t th at it ex ten d s b ey o n d th e
sam p le period . To co n d u ct su ch a sim u lation for this
m odel, it w as n ecessa ry to re-estim ate th e m o d el for a
su b p erio d w ithin th e full sam p le p eriod . All eq u atio n s
o f th e m od el w ere re-estim ated w ith d ata th rou gh
1967. T h e period o f th e e^c ante d yn am ic sim u lation is
1968 and 1969. T h e resu lts are su m m arized in ch a rt 2
and in tables 8 and 9.
T h e s u c c e ss o f th e e\ ante d ynam ic sim u lation can
be a ssessed by co m p arin g it w ith th e track ing reco rd



o f th e f',v post sim u lation for th e sam e period. A co m ­
p ariso n o f th e erro rs a sso cia te d w ith th e e,\ ante sim u ­
latio n w ith th o se o f th e c.x post sim u lation (w here th e
erro rs in b o th ca se s are co m p u te d w ith re feren ce to
a ctu a l values) su ggests that any stru ctu ral shifts that
o cc u rre d in th e 1 9 6 8 -6 9 p erio d w ere n o t o f su ch a
m agn itu d e th at th e c,\ ante trackin g ability o f th e
m odel w as significantly d ifferent from that o f c.x post
sim u lation .
Any c o n c lu sio n s ab o u t th e tracking ability o f th e
m od el are n ecessa rily tentative, b e c a u se th ey are
b a sed o n only o n e e\ ante d yn am ic sim u lation ex p eri­
m en t. N evertheless, th e se resu lts provide a tentative
basis for co n fid e n ce in the tracking ability o f the
m o d el in estim atin g th e ec o n o m ic resp o n se to m o n e­
ta iy an d fiscal actio n s. U nfortunately, it is difficult to
co n d u ct ad d ition al tests o f th is type for o th e r su b p e ­
riods in th e sam ple, b ec a u se d egrees o f freed o m are
severely re d u ce d w h en th e sam p le perio d is sh o rt­
en ed furth er.

57

FEDERAL RESERVE BANK OF ST. LOUIS

OCTOBER 1986

USING THE M ODEL FOR CURRENT
ANALYSIS
T h e m o d el is u sed in th is sectio n to sim u late th e
effects o f p o ssib le fu tu re rates o f m o n etary ex p an sio n
o n spendin g, output, p rices, u n em p loy m en t an d in ­
terest rates, given th e e c o n o m ic circ u m sta n ce s o f late
1969 an d early 1970. Sim u lation o f th e se alternative
co u rses o f m o n eta iy actio n su ggests how th e m od el
m ay provide in fo im atio n w h ich will be helpful to
policym akers.

C h a r t II

Results of
Ex Ante Dynamic Simulation
A n n u a l R ates o f C h a n g e

Sim u lations o f th e m od el are co n d u cte d only for
alternative rates o f m o n e ta iy ex p an sio n . T h is is d o n e
b e c a u se o f th e n atu re o f th e resu lts for th e sp en d in g
eq u ation . T h e n et effect o f a ch an g e in federal ex p e n d ­
itu res o n total sp en d in g (GNP) over a five-quarter p e ­
riod is very sm all if u n a cco m p a n ied by m o n e ta iy e x ­
pan sion.

Short-Run Projections
T h e resu lts o f sim ulating th e m od el for alternative
grow th rates o f m oney, an d for th e grow th o f federal
ex p en d itu res as p ro je c te d in th e fiscal 1971 budget,
are sh ow n in table 10. T h e se sim u lation resu lts reflect
th e a cceleratin g inflation o f th e p ast several y ea rs an d
th e fiscal and m o n eta iy restrain t in fo rce throu gh ou t
1969 an d early 1970. T h e se p ro je c tio n s assu m e th at
em p irical relatio n sh ip s b ased on p ast ex p e rie n ce will
co n tin u e to h o ld in th e n e a r future.
R ates o f ch an g e in th e m o n ey stock w ere co m p u ted
from th e first q u arter o f 1970. T h re e alternative rates
are sh o w n in table 10. T h e “n o -ch an g e c a s e ” co rre­
sp o n d s to th e co u rse o f m o n eta iy a ctio n s in th e s e c ­
o n d h a lf o f 1969. T h e “th ree p e rce n t c a s e ” co rre s­
p o n d s to th e tren d rate o f in crea se in m o n ey from 1961
to 1965. Finally, th e “six p e rce n t c a s e ” re p rese n ts
m o n eta iy actio n s sim ilar to th o se o f 1967 an d 1968.
N o -ch a n g e c a s e — A co u rse o f no ch an g e in the
m on ey sto ck from th e first q u arter o f 1970 w ould lead
to fu rth er re d u ctio n in th e rate o f in cre a se o f total
sp en d in g in 1970 and 1971 (table 10). A slow ing o f total
sp en d in g along w ith upw ard p re ssu res on p rice s from
th e past inflation (anticip ated p rice effect) w ould lead
to co n tin u ed d eclin es in o u tp u t th rou gh 1971. Su ch a
restrictive co u rse o f m o n eta iy a ctio n s w ou ld slow th e
rate o f p rice in crease to a 4 p e rce n t rate by late 1970
a n d to a 2 p e rce n t rate by late 1971. T h e d eclin e in
o u tp u t w ould be acco m p a n ie d by a rise in th e u n e m ­
p loym ent rate to over 7 p e rce n t by late 1971.
T h e effects o f su ch restrictive m o n eta iy a ctio n s on

58




N o te : P r e d ic te d v a lu e s b a s e d o n e s tim a te o f m o d e l
fo r s a m p le p e r io d e n d in g IV /1 9 6 7 .

FEDERAL RESERVE BANK OF ST. LOUIS

OCTOBER 1986

Table 8
Model Simulations
1968
1

GNP Level (billions of dollars)
Actual
Ex Ante1
Ex Post2
Annual Rate of Change in Y
Actual
Ex Ante
Ex Post
Annual Rate of Change in X
Actual
Ex Ante
Ex Post
Annual Rate of Change in P
Actual
Ex Ante
Ex Post
Unemployment Rate (percent)
Actual
Ex Ante
Ex Post
Corporate Aaa Rate (percent)
Actual
Ex Ante
Ex Post
Commercial Paper Rate (percent)
Actual
Ex Ante
Ex Post

II

1969
III

IV

835.3 858.7 876.4 892.5
834.1 856.7 878.9 899.9
834.6 856.7 877.7 897.8

1

II

III

IV

908.7 924.8 942.8 952.2
917.6 932.3 945.9 957.2
914.9 929.4 943.4 955.1

9.7
9.1
9.4

11.7
11.3
11.0

8.5
10.8
10.2

7.6
9.9
9.5

7.5
8.1
7.8

7.3
6.6
6.5

8.0
6.0
6.1

5.9
5.7
5.4

7.4
7.6
6.7

4.0
7.0
5.7

3.2
5.9
4.8

2.6
4.0
3.0

2.0
2.4
1.6

2.2 -0 .4
1.7 0.7
1.1 0.0

3.7
3.3
3.8

4.0
3.4
4.0

4.0
3.6
4.3

4.3
3.8
4.5

4.9
4.0
4.7

5.2
4.1
4.9

5.4
4.2
5.0

4.7
4.2
5.0

3.7
3.9
3.9

3.6
3.8
3.7

3.6
3.5
3.5

3.4
3.3
3.4

3.4
3.2
3.4

3.5
3.2
3.5

3.6
3.3
3.7

3.6
3.5
3.9

6.1
5.8
5.9

6.3
5.9
6.0

6.1
6.0
6.1

6.2
6.4
6.5

6.7
6.5
6.7

6.9
6.7
6.9

7.1
7.0
7.2

7.5
7.1
7.4

5.6
5.1
5.8

6.1
5.1
5.8

6.0
5.1
5.8

6.0
5.6
6.5

6.7
5.7
6.6

7.5
6.0
7.0

8.5
6.6
7.8

8.6
6.7
8.0

4.0
4.9
5.1

Key to Abbreviations:
Y = Nominal GNP
X = Real GNP
P = GNP price deflator
'Simulation based on equations estimated through IV/1967.
Simulation based on equations estimated through IV/1969.

in terest rates w ould b e to k eep th e lon g -term in terest
rate at re cen t levels th rou gh 1970, m ainly b e c a u se o f
the effects o f p ast inflation. By early 1971, th e slow er
advance o f p rices in 1970 and th e slow ing o f o utput
grow th w ould lead to d eclin es in th e lon g -term rate.
T h e sh o rt-term in tere st rate, on th e o th e r han d , w ould
hold at re cen t levels only tem porarily, partly b eca u se
of co n tin u ed restrictive m o n e ta iy actio n s. Sh o rt-term
rates w ould drop sh arp ly by th e seco n d h a lf o f 1970,
reflecting prim arily th e slow ing o f o u tp u t grow th.
Sin ce th e p rice lags are sh o rte r for th e sh o rt-term rate,
th e effects o f p ast inflation are n o t so pervasive as for



th e long-term rate.
T h r e e p e r c e n t c a s e — G rowth o f th e m o n ey sto ck at
a th ree p e rce n t an n u al rate is p resen ted to illu strate
th e effects o f a m o d erate ex p a n sio n o f m on ey. T h is
rate co rresp o n d s to th e tren d rate o f in c re a s e in
m o n ey from 1961 to 1965. In th e cu rre n t e co n o m ic
situation, a th ree p e rce n t rate o f ex p a n sio n in m on ey
w ould rep rese n t a m o d erate easin g o f m o n etary p o l­
icy from its restrictive in flu en ce o f late 1969 an d early
1970.
T h e effect o f su ch ex p an sio n w ould b e to m aintain

59

OCTOBER 1986

FEDERAL RESERVE BANK OF ST. LOUIS
grow th in total sp en d in g at a rate abou t th e sam e as in
th e fourth q u arter o f 1969. Given th e in flu en ce o f past
inflation o n p rices, o u tp u t w ou ld d eclin e slightly
th rou g h 1970, bu t w ould resu m e its in cre a se by 1971.
T h e effect on p rices in 1970 w ould be little d ifferent
from th e n o -ch an g e case, but by late 1971 th e differ­
e n c e w ould b e m arked. In th e th ree p e rce n t case,
p rices w ould still b e rising at a th ree p e rce n t rate by
late 1971 co m p ared w ith a tw o p e rce n t rate fo r th e n o ­
ch an g e case. M od erate ex p an sio n o f th e m o n ey sto ck
lead s to a rise in th e u n em p lo y m en t rate th rou g h 1970
an d 1971. In general, for th is m od el, th e u n em p loy ­
m en t rate rises as long as o u tp u t grow s at le ss th a n a
fou r p e rce n t rate.
T h e lon g -term in terest rate w ould rem ain at re ce n t
levels th rou gh o u t 1970, and n ot until early 1971 w ould
th e effect o f slow er p rice in c re a se s an d o u tp u t grow th
b e en o u g h to offset th e effects o f p ast in flation. T h e
sh o rt-term in tere st rate w ould fall m o re qu ickly th a n
th e long-term rate bu t w ould not fall as m u ch by late
1971 as in th e n o -ch an g e case. Su ch a p atte rn for th e
sh o rt-term rate illu strates th e sh o rt- an d lon g er-ru n
in flu en ce o f q u ick en ed m o n etary ex p an sio n .
Six p e r c e n t c a s e — A six p e rce n t an n u al rate of
in cre a se in m o n ey is sh o w n to illu strate th e effects o f a
su d d en shift to a very rapid rate o f m o n etary ex p a n ­
sion in th e seco n d q u arter o f 1970. Su ch in cre a se in
m o n ey w ould be about th e sam e as d uring 1967 and
1968.
A m a jo r effect o f shifting to rapid m o n etary ex p a n ­
sion w ou ld b e to a d v a n c e th e r a t e o f to tal sp en d in g
grow th. By late 1971, total sp en d in g w ould be in c re a s­
ing at an 8 p e rce n t rate w ith su ch m o n etary a ctio n s.
T h e rate o f p rice in crea se w ould fall som ew h at, h o w ­
ever, b ec a u se o f p ast restrictive m o n etary actio n s. B ut
th e gain in p rice p erfo rm an ce w ould b e sm all, b ec a u se
by late 1971 p rices w ould still be in creasin g at a 4
p e rce n t rate. T h e effects o f p ast m o n etary an d fiscal
a ctio n s, along w ith p ast inflation, w ould lead to a
d eclin e in o u tp u t th rou gh m id-1970. F rom th e n
th rou gh 1971, ou tp u t grow th w ould in crease.
D esp ite a shift to a very rapid rate o f m o n etary
grow th, u n em p lo y m en t w ou ld rise u n til m id -1971.
T h is in crea se in u nem p loy m en t w ould follow b ec a u se
o f th e co n tin u ed in flu en ce o f past nro n etaiy an d fiscal
actio n s. By late 1971, th e recovery in o u tp u t grow th
w ould b e p u sh in g th e u n em p lo y m en t rate b ack dow n.
A shift to rapid m o n etary ex p an sio n h as a p ro ­
n o u n ced effect on m arket in terest rates. T h e lon g­
term rate w ould stay at re ce n t levels th rou g h 1971,
b e c a u se th e in flu en ce o f p ast p rice s (an ticip ated p rice

60




Table 9
Ex Ante vs. Ex Post Simulation: Actual
Minus Predicted — 1/1968-IV/1969 (root
mean squared errors)
Ex Post
Ex Ante
1.45
GNP’
1.26
0.99
1.58
GNP in 1958 Prices'
GNP Deflator'
0.25
0.76
0.14
Unemployment Rate
0.20
0.17
0.26
Corporate Aaa Rate
0.44
Commercial Paper Rate
1.26

'Computed from actual minus predicted annual rates of change.

effect) w ou ld n o t b e offset by a su sta in e d re d u ctio n in
o u tp u t grow th. T h e sh o rt-te rm rate w ou ld fall, in re­
sp o n se to th e tem p o rary re d u ctio n in o u tp u t grow th,
b u t th e d eclin e by late 1971 w o u ld b e le ss th a n for
eith e r th e n o -ch a n g e o r th ree p e rce n t ca se.

Implications o f the Model f o r the
Long Run
S h o rt-ru n p ro sp e cts for ec o n o m ic variables te n d to
d o m in a te p o licy m a k e rs’ d e c is io n s . H ow ever, th e
lo n g er-ru n co n se q u e n ce s o f alternative m o n eta ry p o l­
icie s sh o u ld also b e given co n sid era tio n . T h is m o d el is
in co m p le te for lo n g -ru n analy sis; n ev erth eless, it
y ield s re su lts th a t are o f in tere st a n d m ay n o t b e too far
rem oved from re su lts th a t m igh t evolve from a m o re
co m p lete sp ecifica tio n .3'
W h en sim u latio n s are co n d u cte d for lon g period s
in to th e fu tu re (30 years), th e m o d el d em o n stra te s
p ro p erties c o n siste n t w ith th o se ex p o u n d ed by th e
cla ssica l eco n o m ists. Over th e lon g run, m o n etary
a ctio n s have n o effect on real m ag n itu d es; th e ra te of
grow th o f output, th e u n em p lo y m en t rate an d th e
real rate o f in tere st all te n d to m ove tow ard som e
eq u ilibriu m rate, regard less o f w h ic h rate o f m o n ey

31The shortcomings of the model for the long-run analysis are quite
evident. There are no assumptions specified as to labor force
growth and productivity. Furthermore, there is no investment func­
tion and, therefore, the capital stock is not an endogenous variable.
All long-run assumptions are embodied in assumptions about the
growth rate of potential output. With these assumptions, policy
actions cannot affect the economy’s long-run growth rate.

FEDERAL RESERVE BANK OF ST. LOUIS

OCTOBER 1986

Table 10
Simulation of Alternative Rates of Monetary Expansion
Actual
Projected
Projected Rate of
IV/1969
Change in M'
1/1970 11/1970 111/1970 IV/1970 1/1971

0 Percent
Annual Rate of change in Y
X
P
Unemployment Rate
Corporate Aaa Rate
Commercial Paper Rate
3 Percent
Annual Rate of change in Y
X
P
Unemployment Rate
Corporate Aaa Rate
Commercial Paper Rate
6 Percent
Annual Rate of change in Y
X
P
Unemployment Rate
Corporate Aaa Rate
Commercial Paper Rate

11/1971

111/1971

IV/197

4.0 (5.1 )2
-0.4 (0.1)
4.7 (5.0)
3.6 (4.0)
7.5 (7.4)
8.6 (8.0)

3.5
-1 .3
4.9
4.3
7.4
7.6

3.1
1.6
4.7
4.8
7.5
7.6

1.0
-3 .3
4.4
5.2
7.4
7.1

0.3
-3 .6
4.0
5.8
7.4
6.5

0.7
-2 .7
3.5
6.4
7.3
5.7

0.9
-2 .0
3.0
6.9
7.1
5.0

2.1
-0 .4
2.5
7.4
6.9
4.4

0.9
-1 .0
1.9
7.7
6.7
3.6

4.0 (5.1)2
-0.4 (0.1)
4.7 (5.0)
3.6 (4.0)
7.5 (7.4)
8.6 (8.0)

3.5
-1 .3
4.9
4.3
7.4
7.6

3.8
0.8
4.7
4.8
7.3
7.2

2.9
-1 .5
4.5
5.2
7.3
6.8

3.1
-1 .0
4.2
5.6
7.3
6.4

4.1
0.3
3.8
6.0
7.3
5.9

4.4
0.8
3.5
6.3
7.2
5.5

5.5
2.2
3.2
6.5
7.1
5.0

4.3
1.4
2.9
6.7
6.9
4.5

4.0 (5.1)2
-0.4 (0.1)
4.7 (5.0)
3.6 (4.0)
7.5 (7.4)
8.6 (8.0)

3.5
-1 .3
4.9
4.3
7.4
7.6

4.6
0.1
4.7
4.8
7.2
6.7

4.8
0.2
4.5
5.1
7.2
6.5

6.0
1.6
4.3
5.4
7.2
6.3

7.6
3.3
4.2
5.6
7.3
6.1

7.8
3.7
4.0
5.6
7.3
5.9

8.9
4.8
3.9
5.7
7.3
5.7

7.7
3.8
3.8
5.7
7.2
5.5

Key to Abbreviations:
Y = Nominal GNP
P = GNP Price Deflator
X = Real GNP
M = Money Stock
'Rates of change in money projected from 1/1970. High-employment Federal expenditures projected on basis of fiscal 1971 budget, as
released in January 1970.
2Model estimates.

grow th is m ain tain ed . T h e effects o f alternative rates o f
m o n etary ex p an sio n are on n o m in al m agn itu d es,
nam ely, to tal spending, p rices, an d m arket in terest
rates.
B ased on th e assu m p tio n s o f th e m od el, a six p e r­
c e n t rate o f grow th in m o n ey along w ith a six p e rce n t
grow th rate in fed eral ex p en d itu res, for exam ple,
w ould lead u ltim ately to ab o u t a six p e rce n t rate o f
grow th in total spen ding, a fou r p e rce n t rate o f grow th
in output, a two p e rce n t rate o f in crea se in p rice s and
m arket in terest rates ab o u t tw o p e rce n tag e p o in ts in
e x cess o f th e real rate. Alternatively, a tw o p e rce n t
grow th rate in m o n ey w ould resu lt ap p roxim ately in a
two p e rce n t grow th in total spending, a fou r p e rce n t
rate o f grow th in output, a two p e rce n t rate o f d eclin e
in p rice s and m arket in terest rates abou t tw o p e rc e n t­
age p o in ts belo w th e real rate. Over th e lon g run, th e



m o d el in d ica tes th at high em p lo y m en t an d p rice sta ­
bility are co m p atib le.

SUMMARY
T h e m ain p u rp o se o f th is stu d y h as b ee n to quantify
th e effects o f m o n etary an d fiscal a ctio n s w ithin a
sm all-m od el fram ew ork an d th ereb y offer an a ltern a ­
tive to existing larg e-scale e c o n o m e tric m o d els. Su ch a
m od el h as b een form u lated an d th e effects o f m o n e ­
ta iy an d fiscal a ctio n s on sp en d in g, output, p rices,
em p lo y m en t an d in tere st rates have b ee n estim ated .
T h e m o d el d eveloped in th is article is prim arily
“m o n eta rist” in ch a ra cte r. T h e estim ated eq u atio n s
in d icate th at m o n eta iy a ctio n s, as m easu red by
ch a n g es in the m o n ey stock, play a strategic role.
F iscal actio n s, as m easu red by h ig h -em p loy m en t fed ­

61

OCTOBER 1986

FEDERAL RESERVE BANK OF ST. LOUIS

eral exp en d itu res, have so m e sh o rt-ru n effects, b u t for
p erio d s o f a y e a r o r m o re th e n et effect o n spending,
ou tp u t and p rices is n ear zero. Sim u lation s o f altern a ­
tive rates o f m onetary ex p an sio n p ro d u ce sh o rt-ru n
an d lon g -ru n re sp o n ses w h ich are c o n siste n t w ith th e
gen eral m o n etarist view o f th e eco n om y.
O ne o f th e c h ie f advantages o f this m od el is th at it
d ep en d s prim arily on in form ation ab o u t o n ly two
variables — th e m oney sto ck and hig h -em p loy m ent
ex p en d itu res.3 C on sid erable insigh t can be gained
abou t th e p attern o f ex p e cted m ovem ents o f certa in

32This feature has led John Deaver to conjecture that the standard
error of forecast in the Andersen-Jordan model may be far lower
than that of the FRB-MIT model. See his “Monetary Model Build­
ing,” Business Economics (September 1969), p. 30.

strategic e co n o m ic variables by co n sid erin g a lte rn a ­
tive co u rses o f m o n etary a n d fiscal a ctio n s. However,
sin ce th e m od el is lim ited to on ly m o n etary an d fiscal
in flu en ces, to th e ex clu sio n o f o th e r in d e p en d e n t
forces, it is n ot su itab le for ex a ct forecastin g .*' Its
prim ary p u rp o se is to m easu re th e gen eral p a tte rn o f
in flu en ce o f m o n etary an d fiscal a ctio n s on several
strategic ec o n o m ic variables. Sin ce th e eco n o m y is
view ed as b ein g b asically stable, o th e r fa cto rs in ­
flu en cin g to tal spen din g, o u tp u t an d p rices are n ot
co n sid ere d to be o f great im p o rta n ce in estim a tin g th e
re sp o n se to m o n etary an d fiscal a ctio n s.

“ See Andersen and Jordan, pp. 15,23, 24, and Leonall C. Andersen,
“Money in Economic Forecasting,” Business Economics (Septem­
ber 1969), p. 17.

Appendix A
Explanation of the P rice Equation
The price equation (omitting timescripts and lags) is
AP = f (D, AP*),
where D, demand pressure, is defined as
D = AY - (X1 - X).
AY is the change in total spending, (X1 — X) is the GNP gap,
that is, the difference between potential and actual output,
and AP' is anticipated price change. This specification of
the price equation is based on standard theoiy of macroeconomic equilibrium.
M acroeconomic equilibrium can be depicted graphically
as in figure 1. The solid downward-sloping line, X", is the
total spending line, which represents the combinations of
prices and output consistent with a particular level of total
spending, Y. This total spending line can be interpreted as
total demand for output.
The upward-sloping line, labeled Xs, is the total supply
line. This line corresponds to that combination of prices
and output which maximizes profits of firms, given the
prices of factors of production, the degree of competition
among firms and the stock of human and physical capital
(defined to embody the state of technology).
The intersection of total supply and total demand deter­
mines the levels of output and prices. The equilibrium price
level is that level which equates the amount of output
supplied with the amount demanded.
The focus of the model is on the change in prices and the

62




Figure I

M a c r o e c o n o m i c E qu i l i b r i um
(Determination o fO u tp u t and Prices)

FEDERAL RESERVE BANK OF ST. LOUIS

OCTOBER 1986

ch a n g e in o u tp u t. In term s o f figure 1, c h a n g e s in p ric e s
a n d o u tp u t are b ro u g h t a b o u t by sh ifts in d e m a n d and/or
sup p ly. S in ce X" is d raw n fo r a level o f to tal sp e n d in g , a shift
o f th at lin e up w ard a n d to th e rig h t to Xy+ v re p re s e n ts an
A
in c re a se in to tal sp e n d in g . If th e to tal su p p ly lin e re m ain s
fixed, th e effect o f AY o n p ric e s d e p e n d s o n (1) th e m ag n i­
tu d e o f AY, an d o n (2) th e slo p e o f th e to tal su p p ly lin e, Xs.

tw een X1 — Xs a n d th e slo p e o f Xs. A ssu m in g th at th is
re la tio n sh ip is a p p ro x im a te ly lin e a r w ith in th e ran g e o f
e x p e r ie n c e s in c e 1955, a n d th at th e o bserved v alu es fall on
th e su p p ly lin e, th e effect o f a v ariab le slo p e fo r X s c a n b e
ap p ro x im a te d by X' — X. In th is w ay th e term [AY — (X1 — X)]
b rin g s to g e th e r b o th th e m ag n itu d e o f d e m a n d sh ift a n d the
slo p e o f th e su p p ly lin e.

T h e p u rp o se o f th e m od el is to e stim a te th e re s p o n s e o f
sp en d in g , ou tp u t, a n d p ric e s to m o n e ta iy a n d fiscal
a ctio n s, n o t to te st a h y p o th e siz e d stru c tu re . C o n se q u e n tly ,
ra th e r th a n a tte m p t to d e te rm in e th e s h a p e o f th e total
su p p ly lin e e m p irically , its v ariable slo p e is p ro x ied by th e
d ifferen ce b e tw e e n p o te n tia l o u tp u t a n d a ctu a l o u tp u t. As
d raw n in figure 1, th e re is a o n e -to -o n e re la tio n sh ip b e ­

T h e o th e r term in th e p ric e e q u atio n , a n tic ip a te d p rice
c h a n g e, AP*, is c o n sid e re d a s a se p a ra te in flu e n c e o n p ric e s .
In te rm s o f figure 1, th e a n tic ip a te d p ric e term is a shift
p a ra m e te r fo r th e total su p p ly lin e (an in c re a s e in AP* sh ifts
Xs up w ard an d to th e left). In clu d in g it in th is w ay a llow s fo r
th e in flu e n c e o f p a st p ric e s o n c u rre n t p ric in g p o lic ie s o f
firm s a n d facto rs o f p ro d u c tio n .

Appendix B
G raphical Illustration of the Model
T h e w ork in gs o f th e m o d e l c a n b e d e m o n s tra te d w ith
g ra p h ical te ch n iq u e s . Figu re 2 is a re p re s e n ta tio n o f th e
c o re o f th e m od el, sh o w in g th e d ete rm in a tio n o f c h a n g e s in
sp en d in g , o u tp u t, a n d p ric e s.
Panel A o f figure 2 is a g ra p h ica l re p re s e n ta tio n o f the
to tal s p e n d in g e q u a tio n w ith AM o n th e h o riz o n ta l axis an d
AY o n th e v ertical axis. C h an g e s in AE sh ift th e to tal s p e n d ­
ing lin e.
P an el B sh o w s p ric e s (AP) as a fu n ctio n o f AY. A s h o rt-ru n
p rice lin e (AP,) is d raw n c o n s is te n t w ith e m p iric a l resu lts
sh ow in g th at AP is n o t v e iy sen sitiv e to AY in th e sh o rt ra n .
Im p o rta n t d e te rm in a n ts o f th e p o sitio n o f th e s h o rt-ru n
p ric e lin e are th e siz e o f th e GNP g ap a n d a n tic ip a te d p rice
ch a n g es. T h e lo n g -ru n p ric e lin e (A P(LR)) is d raw n to sh o w
th e re la tio n sh ip b e tw e e n AP a n d AY w h e n th e GNP gap is
z ero a n d a n ticip a te d p ric e s are eq u al to a c tu a l p ric e s. Its
s lo p e (45 d eg rees from its o rig in o n th e AY axis) is b a s e d o n
th e m o n e ta rist view th a t in th e lo n g ru n , AM in flu e n c e s only
AP.
P anel C e x p re ss e s th e to tal sp e n d in g id e n tity in g ra p h ica l
te rm s. T o tal s p e n d in g is d ivided b e tw e e n o u tp u t an d
p ric e s ; to reflect th is, th e lin e in p a n e l C is d raw n as a 45

In p a n e l D, th e AX, lin e sh o w s th e re la tio n sh ip b e tw e e n
m o n ey (AM) a n d o u tp u t (AX) as d erived from th e o th e r th re e
p an e ls. T h e e q u a tio n fo r th is lin e is n o t sh o w n in e x h ib it 1
in th e text, b u t it c a n b e d erived from th e o th e r e q u a tio n s o f
th e m od el.
Figu re 2 is d raw n to re p re s e n t a n in itial eq u ilib riu m fo r a
given AM, w h ic h h a s a s so c ia te d w ith it th e sh o rt-ru n p ric e
a n d o u tp u t lin es, AP, a n d AX,. T h e effect o f a c h a n g e in AM,
given AE, is sh o w n as a m o v e m e n t alo n g th e s p e n d in g lin e
in p an el A from © to © . Given th e in itial p ric e lin e, AP,, and
th e c h a n g e d AY, th e effect o n p ric e s a n d o u tp u t is sh o w n in
p a n e ls B, C an d D as a m o v em en t from © to © .
T h is c a se illu stra te s th e im p a c t o f a c h a n g e in AM in th e
sh o rt ru n . F o r lo n g e r p erio d s, a n tic ip a te d p ric e c h a n g e s
a n d th e GNP gap w ill also ch a n g e ; th ey b e c o m e e n d o g e n o u s
va ria b les in a lo n g -ru n m o d e l. T o illu stra te th e e ffe cts fo r th e
long ru n, th e lo n g -ru n p ric e lin e , AP(LR), in p a n e l B, is
relevan t. T h e in te rp re ta tio n o f th e lo n g -ru n p ric e lin e is th a t
c h a n g e s in AM are re fle cte d o n ly in AP, w ith AX d e te rm in e d
by c o n sid e r a tio n s o f r e s o u rc e g ro w th a n d te ch n o lo g y . T h e
h o riz o n ta l lint; in p a n e ls G a n d D is th e lo n g -ru n re latio n
b e tw e e n p ric e s an d o u tp u t.
In th e sh o rt-ru n , th e s o lu tio n o f th e m o d el n e e d not lie o n

d eg ree lin e w ith its p o sitio n d e te rm in e d by th e m ag n itu d e
o f total sp e n d in g (AY). T h e re is a fam ily o f 45 d eg re e lin es,
o n e fo r e a c h p o ssib le AY. A lso in c lu d e d in p an el C is a
h o riz o n ta l lin e re p re se n tin g th e lo n g -ru n g row th rate of
o u tp u t. It is sh o w n a s a h o riz o n ta l lin e to in d ic a te th a t long-

th e lo n g -ru n p rice lin e in p a n e l B
lin e in p a n e ls G a n d D). However, a
(show n as a sh ift o f th e AP a n d AX
te n d to m ove e q u ilib riu m to w ard

ru n o u tp u t grow th is e x o g en o u sly d e te rm in e d by re s o u rc e

o u tp u t lin es, as a n tic ip a te d p ric e s a d ju s t to a ctu a l p ric e s

grow th an d tech n o lo g y .

a n d th e GNP gap g o e s lo zero .




(or th e lo n g -ru n o u tp u t
s u c c e s s io n o f sh o rt ru n s
lin e s to AP, an d AXJ will
th e lo n g -ru n p ric e an d

63

OCTOBER 1986

FEDERAL RESERVE BANK OF ST. LOUIS

F ig u r e II

Model in Graphical Form
(A)
S p e n d i ng Equati on

Appendix C
Alternative P rice Equations
T h e m o d e l c o n sis ts , for th e m o st part, o f e q u a tio n s w h ic h
have b e e n e stim a te d in p rev iou s stu d ie s. T h e p u rp o se o f
th is p a p e r is to c o m b in e th e e q u a tio n s in a w ay w h ic h
re p re s e n ts th e g en eral m o n e ta rist view.
T h e p rim ary d istin g u ish in g featu re o f th is m o d el, o th e r
th a n th e re d u ce d -fo rm to tal sp e n d in g e q u a tio n , is th e in ­
c lu sio n o f a p ric e a n ticip a tio n s v ariable in th e p ric e e q u a ­
tio n . Tw o altern ativ e m e th o d s o f in tro d u c in g p ric e a n tic i­
p a tio n s w ere c o n sid e re d . O ne altern ativ e b y p a sse s the
p re c is e form o f th e p ric e a n ticip a tio n s fu n c tio n a n d u se s
th e lo n g -term m ark et in te re st rate (yield o n c o rp o ra te Aaa
b on d s) as an in d e p e n d e n t v ariable in th e p ric e e q u a tio n .
T h e o th e r a ltern ativ e b y p a sse s b o th p ric e e x p e c ta tio n s an d
in te re st rates, an d in tro d u c e s c h a n g e s in m o n ey as an




64

(B)
Price E q u a t i o n

in d e p e n d e n t v ariable in th e p ric e e q u a tio n . S u c h a s p e c i­
fica tio n allow s m o n e ta ry a c tio n s to serve a s a p ro x y for
a n ticip a te d p ric e s .

A Market Interest Rate in the
Price Equation
T h e first altern ativ e re p la c e s th e p ric e a n tic ip a tio n s vari­
ab le w ith th e lo n g -te rm m ark et in te re st ra te .' T h e ra tio n a le
is th at th e p ro c e ss o f p ric e a n tic ip a tio n s fo rm a tio n is so
co m p le x th a t it d efies m e a s u re m e n t. H ow ever, th e re se e m s
to b e ag re em e n t th a t th e level o f m ark e t in te re s t ra te s
re fle cts a n ticip a te d p ric e c h a n g e s , h o w ev er fo rm ed . T h u s
th e m ark et in te re st ra te c a n b e u se d a s a p ro x y fo r p rice
a n ticip a tio n s.

'The suggestion for using the interest rate in the price equation came
from the Money and Banking Workshop at the University of Chicago.

FEDERAL RESERVE BANK OF ST. LOUIS

OCTOBER 1986

Table 11

Alternative Price Equations (Dependent Variable — APt)
Sample Period: 1/1955—
IV/1969 ________
Independent Variable
“ Dt_, AP*t (R\_,X,_,).01 SAM, , Constant R2
*
*
2.70 .87
Price Anticipations Specification’ .09 .86
(7.07)
(9.18) (8.55)
.11
1.93 .88
.09
Interest Rate Specification2
(8.72)
(8.73)
(4.10)
.06
Money Stock Specification3
2.61
2.11 .86
(4.61)
(7.82) (4.22)

SE DW
1.07 1.41
1.04 1.49
1.11 1.37

’Where i goes from 0 to 5.
2Where i goes from 0 to 10.
Where i goes from 0 to 9.
‘ Not estimated for this equation.
NOTE: Regression coefficients are the top figures; their “t” statistics appear below each coefficient,
enclosed by parentheses. R2 is the percent of variation in the dependent variable which is
explained by variations in the independent variable. SE is the standard error of the estimate. DW
is the Durbin-Watson statistic.

S in ce in te re st rate s re fle ct factor's o th e r th a n p ric e a n tic i­
p atio n s, in clu d in g th e in te re st rate d o es n o t prov id e a c le a n
m e a su re o f p ric e a n ticip a tio n s . U sing th e m ark et in te re st
rate allow s th o se facto rs in flu e n c in g th e real rate o f in te re st
to e n te r in d ire ctly as a n in flu e n c e o n p ric e s . In g en eral,
how ever, it h a s b e e n arg u ed th a t th e real r ate o f in te re st is
very stable.
Fo llow in g th is reaso n in g , th e p ric e e q u a tio n w as e sti­
m ated by in clu d in g th e lo n g -te rm in te re st rate. T h e re su lts
are sh o w n in tab le 11. T h e co e fficie n t o f th e inter e st rate
variable is sig n ifican t at th e five p e rc e n t level for th is s p e c i­
ficatio n , a n d th e su m o f th e c o e fficie n ts fo r th e d em a n d
p re ssu re v ariable is ro u g h ly th e sa m e a s fo r th e p ric e a n tic i­
p a tio n s v ersio n o f th e e q u a tio n . H ow ever, th e le n g th o f th e
lag s tru c tu re is lo n g er, in d ic a tin g th a t th e re s p o n s e o f
p ric e s to ch a n g e s in d em a n d p re s su re m ay b e slo w e r th a n
in th e b a s ic e q u atio n . B ut th is n e e d n o t im ply th a t p rices
are slo w e r to r e sp o n d to m o n e ta iy a c tio n s , s in c e th e m ag n i­
tu d e o f th e in te re st rate c o n trib u tio n to p ric e c h a n g e is
sm a lle r th a n w ith th e p ric e a n tic ip a tio n s s p e cific a tio n .

Money in the Price Equation
Several o bserv ers have b e e n critic a l o f p ric e e q u a tio n s
th at d o n o t in c lu d e m o n e ta iy v ariables d irectly . As sh o w n
in th e text, e x clu d in g m o n e ta iy v ariab les fro m th e p rice
e q u a tio n d o es n o t n e c e ss a rily im p ly a n o n -m o n e ta ry th e o ry
o f in flatio n .2 S u ch a c o n c lu s io n c a n n o t b e d erived by e x a m ­
in in g th e p ric e e q u a tio n alo n e, b u t re q u ire s an e x a m in a tio n

2See Fand, “Some Issues in Monetary Economics,” pp. 20-23.



o f th e w h o le m o d el, a n d th e lin kages b e tw e e n m o n ey an d
p ric e s in p a rticu la r.
T h e s e c o n d altern ativ e th a t is c o n sid e r e d is b a s e d o n th e
c e n tra l p ro p o sitio n o f th e q u a n tity th e o iy — th a t ch a n g e s
in m o n ey a re u ltim ately re fle cte d in ch a n g e s in th e p rice
level. A ccord in gly, c u rre n t a n d p a s t c h a n g e s in m o n e y are
u se d as a p roxy to m e a su re a n tic ip a te d m o v e m e n ts in
p ric e s .3 T h o u g h th is ra tio n a le fo r in c lu d in g m o n ey is s o m e ­
w h at n a rro w e r th a n th at p ro p o se d by s o m e m o n e ta iy e c o n ­
o m ists, th e d ire c t an d in d ire c t e ffe cts o f m o n e y a re b e in g
m e a su re d o n c e it is in c lu d e d in th e p ric e e q u a tio n .
T h e p ric e e q u a tio n in corp or a tin g c u rr e n t a n d lagged
v alu es o f c h a n g e s in m o n e y is sh o w n in tab le 11. E x c e p t for
th e c u rre n t q u arter, th e c o e fficie n ts are sig n ifican t fo r n in e
lagged qu artet's. T h e effect o f in c lu d in g c h a n g e s in m o n ey
lo w ers th e su m o f th e c o e fficie n ts o n th e d e m a n d p re s su re
v ariable, h ow ever. T h e overall e x p la n a to ry p o w e r o f th e
e q u a tio n is ab o u t th e sam e as for th e p rice a n ticip a tio n s
m o d el.

Comparison o f the Alternatives
T o co m p a re th e p ric e e q u a tio n in th e text w ith th e tw o
altern ativ e s in th is ap p e n d ix , th e m o d el w as sim u la te d w ith
e a c h o f th e th re e d ifferen t s p e c ific a tio n s from 1965 th ro u g h
1969. T h e p e rio d sta rtin g in 1965 is u se d b e c a u s e th e re la ­
tive tra ck in g ab ility o f th e m o d e ls d u rin g a p e rio d o f a c c e le r ­
a tin g in flatio n is e sp e c ia lly relevan t in a s se s sin g th e c u rre n t

3This suggestion was made by Professors David Fand and Allan
Meltzer.

65

FEDERAL RESERVE BANK OF ST. LOUIS

O CTOBER 1986

Table 12
GNP Price Deflator Alternative Ex Post Simulations: Actual
Minus Predicted (compounded annual rates of change)
Price Anticipations
Interest Rate
Money Stock
Specification
Specification
Specification
0.6
1965 I
0.3
-0 .5
II
0.2
-0 .2
-1 .0
-0 .7
III
-1 .0
-1 .7
IV
-0 .2
-0 .4
-1 .0
1.0
1966 I
1.0
0.4
1.4
II
1.5
1.0
III
0.8
0.8
0.6
IV
0.2
0.1
0.3
1967 I
-0 .3
-0 .3
-0 .2
II
-0 .8
-0 .8
-0 .8
III
1.0
1.1
0.9
IV
1.3
1.4
1.1
0.4
1968 I
0.4
0.3
II
0.5
0.7
0.6
III
0.2
0.7
0.4
IV
0.2
0.9
0.3
0.6
1969 I
1.4
0.7
II
0.7
1.6
0.8
III
0.8
1.7
1.0
IV
0.1
0.9
0.5
Average Absolute
Error
0.60
1965-69
0.86
0.71
1965-67
0.71
0.74
0.79
0.44
1968-69
1.04
0.58
Root Mean
Squared Error
1965-69
0.50
0.96
0.63
0.67
1965-67
0.76
0.79
1.27
1968-69
0.25
0.39

e c o n o m ic s itu a tio n . S in ce th e p ric e e q u a tio n is th e o n ly
p art th a t v aries from o n e m o d e l to th e n ex t, o n ly th e re su lts
fo r th e rate o f c h a n g e o f p ric e s are re p o rte d (see ta b le 12).
T h e p ric e a n ticip a tio n s s p e c ific a tio n h a s th e sm a lle st
average a b so lu te e rro r a n d th e sm a lle st ro o t m e a n sq u a re d
e rro r fo r th e p e rio d . D u rin g th e last tw o y e a rs o f th e p erio d ,
1968 a n d 1969, e a c h o f th e altern ativ e s p e c ific a tio n s te n d s to
u n d e re s tim a te p ric e c h a n g e s . H ow ever, fo r 1968 a n d 1969,
th e p ric e a n ticip a tio n s s p e c ific a tio n ag ain lias b o th th e
sm a lle st average a b so lu te e rro r a n d ro o t m e a n sq u a re d
error.

Conclusions
An e x a m in a tio n o f th e m o d el re fle ctin g th re e d ifferen t
s p e c ific a tio n s fo r th e p ric e e q u a tio n in d ic a te s th a t n o n e o f
th e s p e c ific a tio n s is cle a rly s u p e rio r as ju d g ed by c o n v e n ­

66




tio n a l c rite ria . A p o licy m a k e r m ig h t w ell c o n s id e r th e
re su lts p ro v id ed by e a c h o f th e th re e .
W h en s im u la tio n s a re p e rfo rm e d fo r 3 0 -y e ar p e rio d s b e ­
g in n in g in 1970, th e p ric e a n tic ip a tio n s v ersio n las p re ­
s e n te d in th e text) a p p r o a c h e s c lo s e s t a lo n g -ru n c la s sic a l
so lu tio n . F o r th e o th e r tw o s p e c ific a tio n s th e u n e m p lo y ­
m e n t ra te d o e s n o t sta b iliz e at th e s a m e level fo r a ltern ativ e
g ro w th ra te s o f m o n ey . T h e s e tw o a ltern a tiv e s y ie ld th e
sam e eq u ilib riu m grow th ra te s o f o u tp u t fo r altern ativ e
grow th ra te s o f m o n ey , b u t s in c e th is ra te is a p p ro a c h e d
asy m p to tically , u n e m p lo y m e n t s ta b iliz e s at a d iffe re n t rate
fo r e a c h altern ativ e g row th ra te o f m o n e y .4

“Supplementary materials relating primarily to the long-run simula­
tions are available on request.

FEDERAL RESERVE BANK OF ST. LOUIS

OCTOBER 1986

Leonall C. A ndersen: A Biographical Sketch




A n d y w as b orn in M arshall, M innesota, on N o v e m b e r 4, 1924. He
atten d ed Gustavus A d olp h u s C ollege, w h e re he received a B.S. in
business ad m in istration in 1949; th ree years later, h e e arn ed an M.S.
in E con om ics from the U niversity o f Illinois.
He jo in e d the faculty at St. O laf C ollege in N orth field, M innesota,
in 1955 as an assistant professor, w h ile sim u ltaneou sly p u rsu ing
graduate w o rk at the U niversity o f M innesota. In 1962, having been
aw a rd ed his Ph.D., he jo in e d the Research D ep artm en t at the
Federal Reserve Bank o f St. Louis.
E xcept fo r a on e-year leave in 1969 as a sen ior staff e c o n o m ist at
the C ou n cil o f E con o m ic Advisers in W ash ington , D.C., A n d y re ­
m ain ed in St. Louis for 16 years. At the St. Louis Federal Reserve
Bank, he rose from e con o m ist (1962-65) to sen ior ec o n o m is t (196566), to vice p resid en t (1966-71), to sen ior vice p resid en t (1971-74), to
e c o n o m ic adviser to the p resid en t (1974-78).
In 1978, A n d y retired from the Bank to accep t an a p p oin tm en t as
p ro fessor o f banking in the C ollege o f Business A d m in istration at the
U niversity o f Florida. In 1981, he retu rn ed h o m e to M in n esota to his
alm a m ater, Gustavus A d olp h u s, as a p ro fessor o f econ om ics, a
p ositio n he h eld until his death on O ctob er 27, 1985.

67

FEDERAL RESERVE BANK OF ST. LOUIS

OCTOBER 1986

Leonall C. A ndersen: A Selected Bibliography
“T h e In c id en c e o f M on etary an d Fiscal M easures on the Structure o f
O utput,” T h e Review o f E c o n o m ic s a n d Statistics, August 1964.
“ F ed eral Reserve O p en M arket T ransaction s an d th e M o n e y Sup­
p ly,’’ Federal Reserve Bank o f St. Louis Review, A p ril 1965.
“ Im p lem en ta tio n o f F ed eral Reserve O p en M arket P o lic y in 1964’’
(w ith Jules M. Levine), Federal Reserve Bank o f St. Lou is Review,
June 1965.
“ Seasonal M ovem en ts in Finan cial Variables — Im p a ct o f F ed eral
Reserve an d Treasu ry,” B u siness a nd G o v ern m en t Review, U n iver­
sity o f M issouri, July-August 1965.
“A P rin cipal C om p o n en ts T est o f Bank Debits as a L ocal E con o m ic
In d ic a to r” (w ith W illard T. C arleton), T h e Jo u rn a l o f B usiness,
O ctob er 1965.
“ Federal Reserve O p en M arket O perations in 1965: O bjectives,
Actions, and A c c o m p lish m e n ts ” (w ith Elaine R. G oldstein), F e d ­
eral Reserve Bank o f St. Louis Review, June 1966.
“A M e th o d o f U sing D iffu sion In d exes to In d ica te th e D irectio n o f
N ational E con o m ic A ctivity ” in P a pers a n d P ro ceed in g s, Business
and E con o m ic Statistics Section, An nual M e etin g o f the A m erican
Statistical Association, August 1966.
“A T est o f M o n e y M arket C on d ition s as a M eans o f Short-Run
M o n e ta iy M a n a gem en t” (w ith Jules M. Levine), T h e National
Banking Review, S ep tem ber 1966.
“T h re e A p p ro a ch es to M o n e y Stock D eterm in a tion ,” F ed eral R e­
serve Bank o f St. Louis Review, O ctob er 1967.
“ F ed eral Reserve D efensive O p eration s an d Short-Run C on tro l o f the
M o n e y Stock,” T h e Jo u rn a l o f Political E co n o m y , M arch -A p ril
1968.
“ 1967 — A Y ear o f C onstraints on M o n e ta iy M a n a g e m en t” (w ith
M ich ael O. Rigg), Federal Reserve Bank o f St. Louis Review, M ay
1968.
“T h e M o n e ta iy Base — E xplan ation and A n alytical U se” (w ith Jerry
L. Jordan), Federal Reserve Bank o f St. Louis Review, August 1968.
“ M on etary and Fiscal A ctions: A T est o f T h e ir Relative Im p o rta n ce in
E con o m ic S tabilization ” (w ith Jerry L. Jordan), F ed eral Reserve
Bank o f St. Louis Review, N o v e m b e r 1968.
“T w o M o n e ta iy T erm s D efin ed ,” Banking, Journal o f the A m erican
Bankers Association, M arch 1969.
“ M o n e ta iy and Fiscal Actions: A T est o f T h e ir Relative Im p o rta n ce in
E con o m ic Stabilization — R ep ly” (w ith Jerry L. Jordan), Federal
Reserve Bank o f St. Louis Review, A p ril 1969.

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FEDERAL RESERVE BANK OF ST. LOUIS




OCTOBER 1986

“Asset M an a gem en t an d C om m ercia l Bank P ortfolio Behavior: T h eo iy and P ra ctice” (w ith Albert E. Burger), T h e Jo u rn a l o f F inan ce,
M ay 1969.
“ C om m en t on T h e C h oice o f In term ed iate E con o m ic Targets,’ ”
A m erica n E c o n o m ic Review, M ay 1969.
“ M o n e ta iy V elocity in E m pirical Analysis: D iscu ssion,” Controlling
M onetary A ggrega tes, Federal Reserve Bank o f Boston, June 1969.
“A d d ition a l E m pirical E viden ce on the R everse-Causation A rgu ­
m en t,” Federal Reserve Bank o f St. Louis Review, August 1969.
“An Evaluation o f the Im pacts o f M o n e ta iy and Fiscal P olicy on
E con o m ic A ctivity,” P apers a nd P ro ceed in gs, Business and E c o ­
n o m ic Statistics Section, Annual M e etin g o f the A m erican Statisti­
cal Association, August 1969.
“ M o n e y and E con o m ic F orecastin g,” B usiness E co n o m ics, S ep tem ­
ber 1969.
"T h e D evelo p m en t o f E xp lan atoiy E con o m ic H ypoth eses fo r M o n e ­
ta iy M a n a gem en t” (w ith Albert E. Burger), S o u th ern Jo u rn a l o f
B usiness, O ctob er 1969.
“ M o n e y M arket C on d ition s as a G uide fo r M on etary M a n a ge m en t”
in T argets a nd Indicators o f M onetary Policy, Karl Brunner, ed.,
C h an d ler Publishing C om pany, San Francisco, California, 1969.
“A M on etarist M o d e l fo r E con o m ic S tabilization ” (w ith K eith M.
Carlson), Federal Reserve Bank o f St. Louis Review, A p ril 1970.
“ Selection o f a M o n e ta iy A ggregate fo r Use in the FO M C D irective,”
O pen M arket Policies a nd O perating P ro c e d u re s — S ta ff Studies,
Board o f G overnors o f the F ederal Reserve System, July 1971.
“ Im p act o f M on eta ry P olicies on the G row th o f Banking in the ’70s,”

Financial Analysts Jo u rn a l, July-August 1971.
“A M on etarist V iew o f D em a n d M an agem en t: T h e U n ited States
E xp erien ce,” Federal Reserve Bank o f St. Louis Review, S eptem ber
1971.
“T h e St. Louis E con o m etric Forecastin g M o d e l,” B usiness E c o ­
no m ics, Sep tem ber 1971.
“A M on etarist V iew o f C urrent Stabilization P olicy ,” A rkansas B usi­
n ess and E c o n o m ic Review, M ay 1972.
“A Look at T e n M on th s o f Price-W age C on trols,” F ed eral R eseive
Bank o f St. Louis Review, June 1972.
“A n E con o m etric Analysis o f the R elation o f M o n e ta iy Variables to
the B ehavior o f Prices and U n e m p lo y m e n t” (w ith K eith M.
Carlson), T h e E c o n o m e tric s o f P rice D eterm ination, O tto Eckstein,
ed., Board o f G overnors o f the F ederal Reserve System, June 1972.

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70



OCTOBER 1986

“T h e A p p ro p ria te T im e Fram e fo r C on tro llin g M o n eta ry Aggregates:
T h e St. Louis E v id e n ce ” (w ith D enis S. Karnosky), Controlling
M onetary A g g reg a tes II: T h e Im plem en ta tion , C o n feren ce P ro ­
ceed in gs, Federal Reserve Bank o f Boston, S ep tem b er 1972.
“ P rop erties o f a M on etarist M o d e l fo r E con o m ic Stabilization ,”
K redit u n d Kapital, P roceed in gs o f th e First K on sta n zer Sem inar
on M o n e ta iy T h e o ry and M o n e ta iy Policy, U n iversity o f K on stanz,
W est Germ any, Karl Brunner, ed., 1972.
“ Statistics fo r Public Financial P olicy,” Statistics: A G uide to the
Unknown, Judith M. Tanur, ed., H old en -D a y Inc., San Francisco,
California, 1972, pp. 321-25.
“A C om p a rison o f Stabilization P olicies 1966-67 an d 1969-70," J o u r ­
nal o f M oney, Credit and Banking, Vol. 5, Part I, February 1973, pp.
26-38.
"T h e State o f the M on etarist D ebate,” Federal Reserve Bank o f St.
Louis Review, Sep tem ber 1973.
"C o m m e n t on 'A N ote on the Effects o f G overnm en t F in an ce on
A ggregate D em an d for G oods and Services,’ ” Public F in a n ce, In ­
ternational Q uarterly Journal, T h e Hague, N etherlands, N o. 3-4,
1973.
"A M on etarist A p p ro a c h to F orecastin g,” M eth o d s a n d T e c h n iq u e s o f
B u siness F o reca stin g (revised ed ition ), Butler, Kavesh an d Platt,
eds., Prentice-H all, Inc., E n g le w o o d Cliffs, N e w Jersey, A p ril 1974.
“T h e U.S. E con o m ic Outlook: P o lic y A sp ects,” R eco rd , C o n feren ce
Board, June 1974.
"St. Louis M o d e l R evisited ” (w ith Keith M. Carlson), International
E c o n o m ic Review , June 1974.
“A M on eta ry M o d e l o f N om in al In co m e D eterm in a tion ,” Federal
Reserve Bank o f St. Louis Review, June 1975.
“ O bserved In c o m e V elocity: A M is u n d e rs to o d Issue in M o n e ta iy
P olicy ,” Federal Reserve Bank o f St. Louis Review, August 1975.
“ Selection o f a M on eta ry A ggregate fo r E c o n o m ic Stabilization ,”
Federal Reserve Bank o f St. Louis Review, O ctob er 1975.
“ Is T h e re a Capital Shortage?: T h e o ry and R ecen t E m p irical Evi­
d e n c e ,” Jo u rn a l o f F inan ce, M ay 1976.
"D ilem m as in th e T ren d s o f Capital and P rod u ctivity,” T h e Jo u rn a l
o f Portfolio M anagem ent, Sum m er 1976.
"T h e O u tlook for Long-R un E con o m ic G row th ,” B u siness E c o ­
no m ics, S ep tem ber 1976.
"S om e C on sid eration s in Using M o n e ta iy A ggregates in the Im p le ­
m en tation o f M o n e ta iy P o lic y ” (w ith D enis S. Karnosky), Federal
Reserve Bank o f St. Louis Review, Sep tem ber 1977.

FEDERAL RESERVE BANK OF ST. LOUIS




OCTOBER 1986

“A M o n e ta iy In terpretation o f In fla tion ” (w ith Denis S. Karnosky),
Analysis o f Inflation: 1965—
1974, Joel Popkin, ed., N ation al Bureau
o f E con o m ic Research, 1977.
' An E xplanation o f M ovem en ts in the Labor-Force Participation
Rate, 1957-76,” Federal Reserve Bank o f St. Louis Review, August
1978.

71