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March 1984, 
Vol. 66, No. 3
Posted 1984-03-01

The Money-GNP Link: Assessing Alternative Transaction Measures

by R. W. Hafer

R. W. Hafer notes that some have questioned the reliability of the link between M1 and GNP, given recent velocity developments in 1982 and 1983. He investigates the empirical relationship between economic activity and two alternative transaction measures of money. These two measures are, respectively, the narrowly defined monetary aggregate, M1, and one that excludes from M1 those checkable deposits that earn explicit interest income, such as NOW accounts. This latter measure is referred to as adjusted M1. Arguing that the introduction of NOW accounts in 1981 represents a major but predictable shift in the relationship between GNP and money, Hafer demonstrates that the difficulty in explaining GNP movements disappears when the adjusted M1 series is used. The author’s analysis shows that, when his measure of transaction balances is adjusted for the NOW account effect, the relationship between adjusted M1 and GNP displays no deterioration in overall “explanatory power” when estimated through 1983. In contrast, equations estimated using the current M1 measure experience about a 30 percent reduction in explanatory power. This result, Hafer argues, “arises from the public’s willingness to view some portion of interest-bearing checkable deposits as savings-type balances.” Based on his empirical results, the author denies the claim that the link between transactions money, properly defined, and GNP has been damaged irreparably.





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