Equilibrium Relationships between Money and Other Economic Variables

Central to the quantity theory of money are a number of important propositions about the long-run equilibrium effects of changes in the nominal stock of money on other economic variables. A standard way of testing these propositions is to use quarterly or annual data, explicitly model the lag structure and then derive the long-run solution of the model from the empirical estimates. An alternative is to use some type of smoothing procedure to approximate positions of equilibrium and then to use these transformed data directly in testing hypotheses. The National Bureau technique of averaging data over reference cycle phases is one such method; Robert Lucas's application of Fourier transforms in Two Illustrations of the Quantity Theory of Money (1980) is another; and John Geweke's method (1982) of frequency decomposition is a third. An entirely different way of approaching the problem is to use cross-country-average rather than time-series data as the basic units of observation. The advantage, according to Lucas, is that, Since the two quantity-theoretic laws [that he examines] are obtained as characteristics of steady states, or limiting distributions, of theoretical models, the ideal experiment for testing them would be a comparison of long-term average behavior across economies with different monetary policies but similar in other respects (p. 1006). In this paper I conduct such an experiment. The data that I use are for 20 OECD countries over the period 1956-80. The specific relationships that I examine are those between money and the price level, money and real income, money and interest rates, and money and exchange rates. In the main the data accord well with the quantity-theoretic model. Classical neutrality holds. There is evidence of a Fisher effect, albeit a less than complete effect, on interest rates. Finally, the data are consistent with long-run purchasing power parity and, hence, correspondingly with a long-run monetary approach to exchange rate determination.