Information variables and the monetary transmission mechanism in Australia

The nature of the relationships between money, credit, asset prices, interest rates, inflation, and output are examined for the case of Australia. The analysis presented is both theoretical and empirical. Ideas from some recent discussions about subsets of these six variables are drawn together to develop a complete (although closed economy) model of the monetary transmission mechanism in Australia today. Proxies for all of the above variables are then studied from the point of view of their information content for future changes in output. The empirical analysis takes the form of Granger tests supplemented by error correction terms when appropriate. The Granger tests suggest that the growth of the M3 money aggregate is an excellent predictor of output growth. Error correction models using all six variables to explain output growth suggest the existence of a long-run relationship between these six variables. Two structural VAR models are also modelled for comparison. They present a confusing picture, at odds with the Granger tests. The conclusion reached on the basis of the Granger tests is that proxies for money, credit, asset prices, and interest rates should be subjected to further empirical testing in the hope of developing a reliable forecasting model.