Federal Reserve Bank of Minneapolis Quarterly Review Vol 19 No 3 Summer 1995 pp 2 11 Some Monetary Facts George T McCandless Jr Warren E Weber Associate Professor of Economics Universidad de Andr s Buenos Aires Argentina Senior Research Officer Research Department Federal Reserve Bank of Minneapolis Abstract This article describes three long run monetary facts derived by examining data for 110 countries over a 30 year period using three definitions of a country s money supply and two subsamples of countries 1 Growth rates of the money supply and the general price level are highly correlated for all three money definitions for the full sample of countries and for both subsamples 2 The growth rates of money and real output are not correlated except for a subsample of countries in the Organisation for Economic Co operation and Development where these growth rates are positively correlated 3 The rate of inflation and the growth rate of real output are essentially uncorrelated The views expressed herein are those of the authors and not necessarily those of the Federal Reserve Bank of Minneapolis or the Federal Reserve System The Federal Reserve System was established in 1913 to provide an elastic currency discount commercial credit and supervise the banking system in the United States Congress changed those purposes somewhat with the Employment Act of 1946 and the Full Employment and Balanced Growth Act of 1978 In these acts Congress instructed the Federal Reserve to maintain long run growth of the monetary and credit aggregates commensurate with the economy s long run potential to increase production so as to promote effectively the goals of maximum employment stable prices and moderate long term interest rates FR Board 1990 p 6 Implicit in these instructions from Congress is the assumption that the Fed has the ability through its monetary policy to control these economic variables Does it Clearly it does have a measure of control over some definitions of money But the links between money and the other economic variables have yet to be conclusively established The facts about those links can help determine how well the Fed can do its job The purpose of this study is to improve upon past attempts to determine what the facts are A central bank s major instrument of monetary policy is the growth rate of the money supply targeted either directly or indirectly through some nominal target like an interest rate or the exchange rate for the country s currency Different central banks choose to adjust different definitions of money whichever they deem appropriate for their direct instrument The target for price stability is typically some measure of the country s inflation rate and the target for real economic activity or production is typically the growth rate of national output A natural way to start to analyze the ability of changes in money growth to affect the rate of inflation or output growth is to examine the statistical correlations between these variables To do that we need to make some choices Do we look for correlations in data over the short run during a quarter or a year for example or do we concentrate on much longer time periods Do we look for correlations within or across countries For reasons explained below we here examine long run correlations over a large cross section of countries although we do check the robustness of our results by determining how sensitive they are to the choice of countries included in the cross section Our findings about these correlations indicate that over the long run the Fed has more ability to follow Congress mandate about inflation than its mandate about production Specifically the correlations that we compute reveal these long run monetary facts There is a high almost unity correlation between the rate of growth of the money supply and the rate of inflation This holds across three definitions of money and across the full sample of countries and two subsamples There is no correlation between the growth rates of money and real output This holds across all definitions of money but not for a subsample of countries in the Organisation for Economic Co operation and Development OECD where the correlation seems to be positive There is no correlation between inflation and real output growth This finding holds across the full sample and both subsamples Studying long run cross country correlations like those we consider is of course not new What is new here is threefold we consider a larger number of countries than have been used before we consider more definitions of money and we consider how sensitive the results are to the choice of subsamples of countries Methodology In this article we examine long run correlations between money growth and other variables because many economists and policymakers have strong reservations about the ability of monetary policy to hit short run targets for either inflation or output Milton Friedman is perhaps the bestknown exponent of this view He has said I don t try to forecast short term changes in the economy The record of economists in doing that justifies only humility quoted in Bennett 1995 We study a cross section of countries rather than just a single country because we want our results to be independent of policy rules If we were to study a single country the correlations we obtained could be an artifact of the particular policy rule or rules being followed there For example suppose a central bank were to follow a constant growth rate rule for the money supply If we examined the time series for the growth rate of money and the inflation rate for that economy we would observe no correlation between these two variables If instead the central bank chose to follow a feedback rule where the growth rate of money was determined by the inflation rate then we would observe a perfect correlation between money growth and inflation We hope that the range of policy rules in our cross section of countries is so broad that the correlations we observe are independent of the policy rules Even if all central banks were following a constant money growth rule we doubt that they d all be following the same one That s true for feedback rules too So by using a large cross section of countries we hope our correlations will be free of policy rule influences Independence of correlations from policy rules is important because we want the correlations we find to be useful for determining whether causal relationships exist While