Money and the U.S. Economy in the 1980s: A Break From the Past?

Abstract

There is a widespread perception that the relationship between money and the U.S. economy has changed in the 1980s.This view is based in part on the belief that the relationship must have changed because the Federal Reserve changed its operating procedure in 1979 and the financial industry began to be deregulated in 1980.It is also based on the perceived unusual recent behavior of the velocity of money (the rate that dollars are spent, as measured by the ratio of the dollar value of output in the economy to the quantity of money).My purpose here is to investigate this view by quantitatively assessing the changes that have occurred since 1979 between money and four other macroeconomic variables: the industrial production index, the consumer price index, the three-month return on U.S. Treasury bills, and the trade-weighted value of the dollar.These variables represent the major categories of economic activity: output, inflation, financial markets, and foreign trade.I find surprisingly weak evidence of a change in the relationship between money and the four macroeconomic variables so far in the 1980s.The results are sensitive to how money is measured and how the data are modeled.Because how to measure money is a controversial question, I have done the entire analysis for six different definitions of money.When money is measured by the St. Louis Federal Reserve Bank's measure of the monetary base, MB, or by MQ, a definition proposed by Spindt (1985), I find no evidence of a change in the *I thank Lars Ljungqvist, now a visiting scholar at the Hoover Institution, Stanford University, for helpful research assistance.1 A period is the data sampling interval, which can be a month, a quarter, or a year.Changes, or differences, can be in terms of the logarithm of the data, in which case they represent growth rates. Charts 1 and 2Has Velocity Changed in the 1980s?

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