Spread as Monetary Policy Indicator

inclusion of anticipated money in the output equation yielded positive money shocks EXPANSIONARY policy in Table 5 which were statistically significant. Anticipated money was found, for the most part, to matter, and as noted in Table 5, did so more strongly when a distinction between positive and negative money surprises was recog- nized. 18 In Tables 2 and 3, for n 5 4, it is reported that the null hypothesis that the sums of the coefficients on positive money shocks, on negative money shocks, and on anticipated money growth are significantly different from zero could not be rejected at the 0.05 level. 19 This result not reported was robust for various lag lengths and for both sample periods. The implication of alternative specifications for the money equation will now be briefly considered. Alternative Specifications of the Equations Intercept and slope dummy variables will now be introduced into the money equation to account for structural change. This will have the effect of altering the measure of expectations. Following Frydman and Rappoport 1987, in equation 1, the intercept is allowed to differ before and after 1963:III and the coefficients of each of the variables GM t2 1 and GM t2 2 are allowed to differ before and after 1971:III. 20 It was found that money equations estimated with these changes were much improved. Results under the heading of “structural shifts in money equation” appear in Tables 4 and 5. There, it can again be seen that for both sample periods, SYMMETRY was rejected over all n, whereas AUDI could not be rejected except for n 5 4. Other results were similar to those already noted.

IV. Spread as Monetary Policy Indicator

In a number of recent papers, the importance of various interest-rate measures as indicators of the stance of monetary policy has been emphasized. In this section, the relevance of distinctions among unanticipated expansionary, unanticipated contractionary, and anticipated policy, when the indicator of monetary policy is taken to be spread, is investigated. 21 Spread was regressed on four-lagged values of itself and on four-lagged values of a number of economic variables. These variables were GM, GY, GB, UR, FEBS, 18 Cover 1992 noted the non-neutrality of money for the period 1951:I–1987:IV. However, because the coefficients on the GM t 1 terms were of the wrong sign in the presence of anticipated money terms, Cover’s preferred regression equation is one in which anticipated money growth terms were excluded. Note that the main finding of Cover concerning an asymmetry between positive and negative money shocks in explaining movement in output continues to be confirmed in this paper. 19 Cover 1992 also reported a similar result when anticipated money was included in the output equation [see Cover 1992, Tables VI and VII, pp. 1273, 1275]. He found that the sums of coefficients on the positive shocks SUMPOS and on negative shocks SUMNEG were not statistically significant at the 0.05 level. When anticipated money terms did not appear in the output equation, Cover 1992, pp. 1269–70 found that SUM NEG was statistically significant at the 0.01 level and that SUMPOS was insignificant. 20 Frydman and Rappoport 1987 introduced these dummy variables to test the robustness of tests of AUDI. They pointed out that the intercept dummy was introduced to catch the observation that money growth rose appreciably during the early 1960s, and the slope coefficients on the first and second lags of GM were allowed to change after 1971.III to capture structural shifts associated with the collapse of the Bretton Woods regime. 21 Spread was measured by the difference between the 3-month commercial paper rate and the 3-month Treasury bill rate from 1971:II. Prior to 1971:II, the 6-month commercial paper rate was used. The spread series was found to be level stationary. ExpansionaryContractionary Monetary Policy 119 and GDP inflation GDINF. 22 GY , GB, and GDINF were not statistically significant for 1949:II–1992:II. Thus, four-lagged values of GM, UR, and FEBS appear along with four-lagged values of spread in the forecasting equation for spread. To begin with, four-lagged values of the dependent variable, GY t , and current and four-lagged values of anticipated change, and positive and negative innovations in spread appear in the output equation. 23 A positive negative surprise in spread indicates that spread was greater less than expected and, hence, that monetary policy was more contractionary expansionary than expected. The coefficients on the monetary policy variables should be negative at least at first. To avoid confusion, MPI t e , MPI t u1 , and MPI t u2 refer to anticipated, unexpected expansionary, and unexpected contractionary policy, respectively. The results of joint estimation of equations for spread and for output for the period 1950:II–1992:II appear in Tables 6 and 7, respectively. Sets I and II are again estimates of equations 1 and 2, and of equations 1 and 3. In the spread equations in Table 6, it can be seen that increases in the rate of money growth and in the budget surplus tended 22 Four-lagged values of each of these variables were retained in the equation explaining spread only if they were jointly significant at the .05 level or stronger. This was the method employed by Mishkin 1982, p. 30. 23 Four lags in the spread terms are indicated by AIC from examination of the output equation before applying a joint estimation. The residuals of the output equation do not show first-order or higher-order serial correlation. Table 6. Monetary Policy Equations with Spread as Monetary Policy Indicator: Nonlinear Joint Estimation 1950:II–1992:II standard errors in parentheses Set I Set II Variable Coefficient p Value Coefficient p Value Constant 0.200 0.077 0.0098 0.147 0.099 0.1386 MPI {1} 0.630 0.055 0.0000 0.690 0.073 0.0000 MPI {2} 20.038 0.067 0.5739 20.083 0.089 0.3512 MPI {3} 0.076 0.067 0.2556 0.066 0.089 0.4544 MPI {4} 0.057 0.053 0.2885 0.168 0.078 0.0313 UR {1} 20.004 0.047 0.9331 20.122 0.061 0.0445 UR {2} 0.118 0.080 0.1422 0.272 0.110 0.0136 UR {3} 20.336 0.085 0.0001 20.356 0.112 0.0015 UR {4} 0.212 0.048 0.0000 0.191 0.061 0.0018 FEBS {1} 0.427 0.109 0.0001 0.320 0.135 0.0176 FEBS {2} 20.036 0.133 0.7896 0.182 0.163 0.2659 FEBS {3} 20.485 0.133 0.0003 20.597 0.180 0.0008 FEBS {4} 0.170 0.127 0.1830 0.167 0.155 0.2823 GM {1} 0.038 0.024 0.1200 0.071 0.028 0.0112 GM {2} 20.015 0.024 0.5376 20.048 0.031 0.1141 GM {3} 20.014 0.025 0.5834 0.002 0.030 0.9214 GM {4} 0.086 0.022 0.0002 0.057 0.027 0.0353 Std. error 0.307 0.301 DW 1.933 1.957 R 2 0.534 0.549 Notes: GM{i} 5 log difference in M1 with lag i; UR{i} 5 civilian unemployment rate lagged i time periods; FEBS{i} 5 federal budget surplus lagged i time periods. In output equation for Set I, a distinction between the effects of positive and negative money shocks was recognized. This distinction was suppressed in Set II. 120 J. Chu and R. A. Ratti Table 7. Output Equations with Spread as Monetary Policy Indicator MPI: Nonlinear Joint Estimation 1950:II–1992:II standard errors and x 2 statistics in parentheses 1 indicates expansionary shock and 2 indicates contractionary shock Set I Set II Variable Coefficient p Value Variable Coefficient p Value Constant 0.750 0.298 0.0119 Constant 1.216 0.288 0.0000 GY {1} 0.372 0.083 0.0000 GY {1} 0.210 0.085 0.0137 GY {2} 0.131 0.082 0.1146 GY {2} 0.102 0.083 0.2178 GY {3} 20.193 0.088 0.0282 GY {3} 20.169 0.085 0.0469 GY {4} 20.054 0.081 0.5054 GY {4} 20.062 0.082 0.4529 MPI e 1.401 0.728 0.0543 MPI e 1.676 0.741 0.0237 MPI e {1} 22.739 0.954 0.0041 MPI e {1} 21.981 0.877 0.0238 MPI e {2} 0.741 0.928 0.4253 MPI e {2} 0.081 0.795 0.9185 MPI e {3} 0.605 0.846 0.4749 MPI e {3} 20.591 0.760 0.4365 MPI e {4} 20.296 0.495 0.5502 MPI e {4} 0.093 0.489 0.8487 MPI u1 20.631 0.574 0.2721 MPI u 20.714 0.218 0.0010 MPI u1 {1} 24.435 0.818 0.0000 MPI u {1} 21.915 0.598 0.0013 MPI u1 {2} 2.734 0.862 0.0015 MPI u {2} 20.043 0.583 0.9410 MPI u1 {3} 0.014 0.829 0.9866 MPI u {3} 0.005 0.529 0.9909 MPI u1 {4} 0.201 0.758 0.7912 MPI u {4} 0.722 0.510 0.1571 MPI u2 21.057 0.356 0.0030 MPI u2 {1} 0.044 0.588 0.9398 MPI u2 {2} 20.898 0.589 0.1276 MPI u2 {3} 20.330 0.559 0.5551 MPI u2 {4} 0.086 0.548 0.8761 Hypothesis Hypothesis MPI e {i} 5 0 a , i 5 0, . . . 4 11.483 0.0425 MPI e {i} 5 0 a , i 5 0, . . . 4 13.684 0.0177 ¥ MPI e 5 0 b , 0.447 0.5034 ¥ MPI e 5 0 b , 5.078 0.0242 MPI u1 {1} 5 0 a , i 5 0, . . . 4 37.892 0.0000 MPI u {i} 5 0 a , i 5 0, . . . 4 22.527 0.0004 ¥ MPI u1 5 0 b , 3.764 0.0523 ¥ MPI u 5 0 b , 4.121 0.0423 MPI u2 {i} 5 0 a , i 5 0, . . . 4 12.477 0.0287 ¥ MPI u2 5 0 b , 5.457 0.0194 MPI u1 {i} 5 MPI u2 {i} c , i 5 0, . . . 4 35.947 0.0000 ¥ MPI u1 5 ¥ MPI u2 d 0.001 0.9764 MPI u1 {i} 5 MPI u2 {i} 5 MPI e {i} c , i 5 0, 1 . . . 4 46.562 0.0000 MPI e {i} 5 MPI u {i} c , i 5 0, 1 . . . 4 12.782 0.0255 ¥ MPI u1 5 ¥ MPI u2 5 ¥ MPI e d 3.647 0.1614 ¥ MPI e 5 ¥ MPI u d 1.275 0.2588 Std. error 0.712 0.794 DW 2.098 2.092 R 2 0.529 0.412 a x 2 5-test of the null hypothesis that the coefficients on MPI e MPI u1 , MPI u2 , or MPI u terms are jointly zero. b x 2 1-test of the null hypothesis that the sum of the coefficients on the MPI e MPI u1 , MPI u2 , or MPI u terms is zero. c x 2 5-test and x 2 10-test of joint pairwise equality and of joint triple-wise equality, respectively, of coefficients on variables indicated. d x 2 1-test and x 2 2-test of pairwise equality and of triple-wise equality, respectively, of sums of coefficients on variables indicated. ExpansionaryContractionary Monetary Policy 121 to raise spread one quarter later, after which time the effect was eroded, and a rise in the unemployment rate tended to reduce spread after three quarters followed by a reversal in the fourth quarter. In the output equation in Table 7, the null hypothesis that distinctions among anticipated, unanticipated positive, and unanticipated negative changes in spread is irrelevant in explaining growth in output SYMMETRY was rejected. The effects of increasing n for the period ending in 1992:II, and for a period ending in 1979:III, are reported in Table 8. Also, results are presented for a period starting in 1957:III. This sample period was included because it matches the period for which results were available on the federal funds rate as the measure of monetary policy. From Table 8, it can be seen that as lag length increased in the spread variables, the null hypothesis of equality of coefficients on MPI u1 , MPI u2 , and MPI e continued to be rejected at the 0.01 level. 24 Expansionary monetary policy, signaled by spread, usually had a statistically signifi- cant effect on output in Table 8. The exception was for the sample ending in 1979:III with n 5 16. It is interesting that contractionary monetary policy signaled by spread was not usually quite as potent, especially for the sample ending in 1979:III. Consistent with the M1 results, spread as an indicator of monetary policy reinforces the conclusion that asymmetries among the effects of anticipated, expansionary unanticipated, and contrac- tionary unanticipated monetary policy on aggregate output are of some empirical impor- tance. 25

V. Federal Funds Rate as Monetary Policy Indicator