What Was Behind the M2 Breakdown?

31 Pages Posted: 10 Jan 2000

See all articles by Cara S. Lown

Cara S. Lown

Federal Reserve Banks - Federal Reserve Bank of New York

Stavros Peristiani

Federal Reserve Bank of New York--Retired

Kenneth J. Robinson

Federal Reserve Bank of Dallas

Date Written: August 1999

Abstract

A deterioration in the link between the M2 monetary aggregate and GDP, along with large errors in predicting M2 growth, led the Board of Governors to downgrade the M2 aggregate as a reliable indicator of monetary policy in 1993. In this paper, we argue that the financial condition of depository institutions was a major factor behind the unusual pattern of M2 growth in the early 1990s. By constructing alternative measures of M2 based on banks? and thrifts? capital positions, we show that the anomalous behavior of M2 in the early 1990s disappears. Specifically, after accounting for the effect of capital constrained institutions on M2 growth, we are able to explain the unusual behavior of M2 velocity during this time period, obtain superior M2 forecasting results, and produce a more stable relationship between M2 and the ultimate goals of policy. Our work suggests that M2 may contain useful information about economic growth during periods of time when there are no major disturbances to depository institutions.

JEL Classification: E4, E5, G2

Suggested Citation

Lown, Cara S. and Peristiani, Stavros and Robinson, Kenneth J., What Was Behind the M2 Breakdown? (August 1999). FRB of New York Staff Report No. 83, Available at SSRN: https://ssrn.com/abstract=192730 or http://dx.doi.org/10.2139/ssrn.192730

Cara S. Lown

Federal Reserve Banks - Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045-0001
United States
212-720-1232 (Phone)

Stavros Peristiani (Contact Author)

Federal Reserve Bank of New York--Retired ( email )

3001 Henry Hudson Pkwy W
Apartment 1C
Bronx, NY New York 10463
United States
718-796-5190 (Phone)

Kenneth J. Robinson

Federal Reserve Bank of Dallas ( email )

PO Box 655906
Dallas, TX 75265-5906
United States
214-922-5365 (Phone)
214-922-5351 (Fax)

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