Monetary Policy and Short-Term Interest Rates: An Efficient Markets-Rational Expectations Approach

Abstract

The impact of a money stock increase on nominal short-term interest rates has been a hotly debated issue in the monetary economics literature.The most commonly held view--also a feature of most structural macro models--has an increase in the money stock leading, at least in the short-run, to a decline in short interest rates.Monetarists dispute this view because they believe that it ignores the dynamic effects of a money stock increase.This paper is an application of efficient markets-rational expectations theory to analyze empirically the relationship of money supply growth and shortterm interest rates-This approach has the advantage over earlier research on this subject in that it imposes a theoretical structure that allows easier interpretation of the empirical results as well as more powerful statistical tests.In the interest of ascertaining the robustness of the results, many different empirical tests are carried out in this paper, and they uniformly do not support the proposition that increases in the money supply are correlated with declines in short rates.

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