proportion. Of course, such sustained in-
creases would be typical only under certain
monetary policies; current money increases
often will be followed by offsetting or rein-
forcing money growth in the future. But if the
money-inflation relation is the same regardless
of the choice of monetary policy, and if money
is neutral, the long-run impact of money on
prices should be unity—since it should be the
same under one policy as under any other. Yet
as shown below, this impact will generally not
be unity if the lag between money and prices
is influenced by anticipations about future
money growth. Our finding thus provides in-
direct evidence that anticipations help deter-
mine the timing of money’s effect upon prices.
Further evidence (again indirect) is provided
by the apparent significant shift in the money-
inflation relation between the two subperiods;
the hypothesis that the relation is the same for
both is nearly rejected for Italy and Japan, and
is easily rejected for all other countries except
Canada. This finding is particularly striking in
view of the fact that the long-run impact of
money on prices generally increased from the
first subperiod to the second. (However, this
is not true of the U.K., where the later-period
results are rather implausible). This might be
expected, however, because we may suppose
that foreign countries’ money growth was sub-
stantially constrained by U.S. growth during
the period of fixed exchange rates.
The evidence in Table 1 is thus consistent
with the proposition that expectations influ-
ence the money-inflation lag. The relation ap-
pears to shift between the two subperiods, pos-
sibly reflecting the difference in constraints on
foreigners’ monetary policy. In addition, the
long-run impact of money on prices often does
not equal unity, as would be the case if the
relation were valid under any monetary policy.
This evidence is far from conclusive, however,
particularly as there are other possible expla-
nations of the apparent shift between the sub-
periods. In particular, autonomous domestic
price changes themselves may have served to
reduce domestic money via international re-
serve changes during the fixed-rate period; and
such feedback from domestic prices to money
could bias our estimates downward. Prelimi-
nary tests indicate that such an influence may
have been important for Germany, Japan, and
the U.K. during this period, although it was
less significant (if at all) for the other countries
considered.17
IL Response to Permanent and Transient Money Changes
The mere observation that expectations can
cause money-inflation relations to vary is of lit-
tle use for practical policy analysis. Toimprove
inflation forecasts, we must know precisely how
expectations affect the timing of money’s im-
pact upon prices, as well as how these expec-
tations are determined. This is potentially a
very difficult task, especially as anticipations
may interact with other sources of the money-
inflation lag in complex ways.
Nonetheless, our arguments suggest a sim-
ple but potentially powerful explanation of the
lagged relation between prices and money.
This explanation is based upon the hypothesis
of a stable relation —one unaffected by mon-
etary policy—not between prices and actual
money, but between prices and that part of
money changes perceived as persistent or per-
manent. In this view, prices respond more to
the permanent than to the transient part of
money variations. Even if only approximately
correct, this view provides some useful guide-
lines as to how inflation forecasting relations
should be altered when policy is substantially
changed. This approach and its implications
are described in detail below, with a more tech-
nical development left to the appendix.
Prices and Permanent Money
An earlier argument suggested that prices in
individual industries are based upon an aver-
age of the level of money expected to prevail
over some future horizon. Consider, for ex-
ample, the situation confronting a firm which
36