Doctoral Dissertations

Date of Award

12-2000

Degree Type

Dissertation

Degree Name

Doctor of Philosophy

Major

Economics

Major Professor

Charles Garrison

Committee Members

Charles Noon, Jean Gauger, Hui Chang

Abstract

This dissertation addresses two issues related to identifying the impact of money on economic activity using disaggregated monetary and real variables. The first is the negative impact of money on interest rates (the liquidity effect). The first step in doing so is to distinguish between exogenous and endogenous money movements. The second is identifying the transmission mechanism by which interest rates affect economic activity. Recent empirical work on the relationship between money and economic activity using the Vector Auto Regression (VAR) method has focused on relationships between aggregate monetary and aggregate real variables. The difficulty in using aggregated data is that some aggregate variables consist of components that have different determinants or different time patterns in their interaction with other variables. The positive correlation between money and interest rates, and between interest rates and investment that have been found by many empirical studies are inconsistent with theories of the liquidity effect of money and the transmission mechanism with interest rate channels. The main argument in this dissertation is that distinguishing between outside and inside money and between residential and nonresidential investment is crucial for identifying the impact of money and interest rates on economic activity. Following the recent trend in studying the relationship between money and output, the VAR method is applied here. This dissertation, however, departs from most of the previous work specifically by dealing with the problem of nonstationarity and cointegration in the data series. The presence of nonstationarity and cointegration found in the data requires the use of the Error Correction (EC) model to estimate the dynamic short-run relationships between the variables. The main conclusion of this study is that exogenous money shocks are correctly measured by nonborrowed reserves (NBR). Movements in NBR produce the expected negative impact of money on interest rates (the liquidity effect) and reflect, to a large extent, the Fed's "leaning against the wind" policy. Disaggregating investment, on the other hand, helps to detect the transmission mechanism by which interest rates affect economic activity. Particularly, the transmission mechanism works through the effect of interest rates on the residential component of investment. Further, the evidence presented in this dissertation underscores the role of residential investment in explaining business cycle fluctuations.

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