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August/September 1983, 
Vol. 65, No. 7
Posted 1983-08-01

Monetary Growth and the Timing of Interest Rate Movements

by W. W. Brown and G.J. Santoni

W. W. Brown and G. J. Santoni re-examine the widely held view that permanent increases in the monetary growth rate cause market interest rates initially to decline, then ultimately to rise above their original levels. The path that interest rates follow when adjusting to a change in the monetary growth rate is important for two reasons. First, if changes in money growth change the ex ante real interest rate, even temporarily, the result will be sizable disturbances in general economic activity. Second, the timing of the adjustment in market interest rates reveals information about the lag in the response of economic activity to changes in monetary policy. Brown and Santoni examine monthly data on interest rates and monetary growth over the period July 1914-February 1983 to determine whether changes in monetary growth induce changes in interest rates and, if so, what the direction, magnitude and timing of the effect are. When the data period is partitioned to control for the effects of the different monetary institutions (for example, the gold standard), they find that interest rates have responded to monetary impulses in the commonly believed manner only since 1971. Even in this case, however, the initial decline in short-term interest rates associated with an increase in the monetary growth rate is quite small; the subsequent rise is proportionate to the increase in money growth. Further, interest rates appear to adjust fully to a change in monetary growth within one year.