III. Summary and Conclusions
It has long been noted that most economic
variables react to past as well as current con-
ditions. Except in a few cases, the sources of
these lags in economic behavior are not pre-
cisely known. Until fairly recently, most lags
were regarded as mechanistically determined
by institutional rigidities, adjustment costs,
and other factors which supposedly do not vary
with government policies. Empirical relations
derived from past data were commonly used
to simulate the effects of policy changes and
to predict economic conditions under policy
regimes very different from those prevailing
during the sample period. However, relations
that used to be regarded as stable have shifted,
often dramatically, with the accelerating infla-
tion of recent decades, and this shift has con-
siderably complicated the task of prediction
and policy analysis. Many analysts have con-
cluded from this experience that expectations
about future economic conditions, including
monetary policies, crucially influence the lags in
economic relations—and that these expecta-
tions become more quickly adapted to chang-
ing conditions than once was thought.
This paper has considered the lags in a cru-
cial relation for forecasting and policy analy-
sis—the relation between inflation and current
and past money growth. We argue that the lag
in money’s effect upon prices can be substan-
tially affected by individuals’ expectations
about future money growth. This implies that
money-inflation forecasting relations will change,
at least eventually, when government policy
alters the relation between current and past
money growth and future money growth. The
estimates of the money-inflation relations for
several industrial countries seem quite consist-
ent with this conjecture. In particular, the
long-run impact of money on prices appears to
have shifted substantially between the Iixed-
and floating-rate periods, and in a plausible
fashion given the nature of those regimes. Fur-
thermore, those relations often do not show
the characteristics that would be expected if
they were invariant to government policies. In
particular, the long-run impact of money on
prices frequently does not equal unity, as
would be expected if those relations were in-
variant to policy.
Finally, we argue that the relative impact on
inflation of the (permanent versus transitory)
components of money growth may be stable
across policy regimes, or at least more stable
than under the standard forecasting relation.
In particular, we argue that prices will react
more to permanent money changes than to
transient changes. If true, this hypothesis pro-
vides at least a rough indication of how infla-
tion-forecasting relations can be adapted to
altered policies. Although the crude evidence
cited here does not confirm this hypothesis, it
could prove useful in further research as we
learn more about the money-supply process
and the expectations surrounding that process.
APPENDIX
This appendix sketches several approaches
to price determination that lead to price-per-
manent money relations similar to those dis-
cussed in Section II. Implications of this rela-
tion for the forecasting of inflation are also
developed. In the following—as in the text—
p(t) refers to the log of the price level, e(t) to
the log of aggregate demand, and m(t) to the
log of money.
Three Simple Models
A. Interest rates, inflation expectations, and
prices
Suppose that prices vary immediately and
proportionately with aggregate demand as in,
P(t) = e(t) (1)
Assume as well that aggregate demand varies
proportionately with the current money stock
and the (short-term) nominal interest rate, as
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