The simple macroeconometrics of the quantity theory and the welfare cost of inflation
Date
2024
Authors
Stewart, Kenneth G.
Journal Title
Journal ISSN
Volume Title
Publisher
Journal of Economic Dynamics and Control
Abstract
The quantity theory of money hypothesizes that the price level is determined through the equilibration of money supply and demand. Predicated on this causal structure, a single-equation error correction model decomposes from a larger vector autoregressive system so as to make available bounds tests for a levels relationship that are robust to the univariate integration properties of the variables. This model is estimated using three monetary aggregates and two money demand specifications, for U.S. and U.K. annual data over the past century and quarterly post-WWII data. The classic homogeneity propositions of the quantity theory are testable, and are found to be most compatible with U.S. annual M2 using log-log money demand with structural change permitted. Nevertheless, the resulting welfare costs are similar to those yielded by the U.K. annual data, being less than one percent of GDP at interest rates experienced during the past century.
Description
I am indebted to the Associate Editor Luca Benati and two anonymous referees for extensive suggestions that have significantly improved the paper, and to Ryland Thomas of the Bank of England for graciously providing me with series updates through 2019 to the Bank’s A Millenium of Macroeconomic Data spreadsheet. A preliminary version of this paper was presented at the 2022 annual meetings of the Canadian Economics Association in Ottawa and in a department seminar at the University of Victoria. I thank participants for their comments, especially Merwan Engineer and Vasco Gabriel.
Keywords
quantity theory of money, money demand, bounds tests, indicator saturation, welfare cost of inflation
Citation
Stewart, K. G. (2024). The simple macroeconometrics of the quantity theory and the welfare cost of inflation. Journal of Economic Dynamics and Control, 162, 104842. https://doi.org/10.1016/j.jedc.2024.104842