Monetary Aggregates and Macroeconomic Performance: The Portuguese Escudo, 1911–1999

Abstract

This paper provided a full characterization of several monetary aggregates over Portuguese's historical economic business cycles. By focusing on the 1911–1999 period, the paper also revisits the issue of the role of money on real macroeconomic outcomes, inspired from the monetarists versus Keynesians debate on quest for validity of money (non-)neutrality. By means of descriptive statistics we first uncover that money changes were associated with changes in real economic activity. Most monetary aggregates are more volatile than GDP, display high serial autocorrelation, are generally countercyclical and lead the economic cycle. Then, through econometric analysis, our results show that our monetary series were characterized by unit roots and were cointegrated with real GDP. Evidence also suggested that money supply Granger-caused real GDP. Finally, both variance decomposition and impulse response function analyses from an estimated BVAR, uncovered a persistent and mutual effect running from a shock in real GDP to monetary aggregates and vice versa, therefore supporting the money non-neutrality hypothesis in the case of Portugal.

KEYWORDS:

• Monetary aggregates
• unit roots
• structural breaks
• cointegration
• causality
• VECM
• BVAR

Acknowledgements

The author is grateful to Luciano Amaral for sharing the data and for early discussions on the topic. The opinions expressed herein are those of the author and the usual disclaimer applies.

Disclosure statement

No potential conflict of interest was reported by the author.

Notes

1 The debate about the relationship between money and economic activity started around the mercantilists’ era. Tomas Malthus was the first to point out that an increase increasing in the amount of the precious metal in circulation would lead to an increase in domestic prices (relative to those in other countries). Later, Locke (1691), Hume, David Ricardo and Mill (1848) confirmed that prices and money in circulation were changing (growing) at the same rate, suggesting money neutrality (i.e. that changes in money do not affect real macroeconomic variables).

2 The money multiplier view of credit creation is still pervasive in standard macroeconomic textbooks including e.g. Walsh (2003), Mishkin (2004) and Abel and Bernanke (2005). Other recent contributions include the works by Borio and Disyatat (2010) and Carpenter and Demiralp (2012).

3 Cambridge economists reformulated Fisher's (1911) ’equation of exchange‘ (the basis for the Quantity Theory) to a new identity called the ’equation of Cambridge’ according to which the amount of nominal money demand and money supply (at the money market equilibrium) is proportionally linked to the nominal income per capita.

4 Theoretically, a decade later Moore (1988) and Wary (1990) developed models in which money supply was an endogenous variable and, hence, monetary policy could affect real variables (non-neutrality of money).

5 According to Friedman and Schwartz (1963), the sharp contraction in economic activity that occurred during the Great Depression (1929–1933) was the result of the big decline in money supply in the same period.

6 The issue of the impact of the money supply on the macroeconomy was also looked at in centrally planned economies. For some authors money played an active role through household behavior (Pickersgill, 1976; Portes, 1983); for others it did not (Hodgeman, 1960; Gedeon, 1985).

7 This endogenous structural break test is a sequential test which utilizes the full sample and uses a different dummy variable for each possible break date. The break date is selected where the t-statistic from the ADF test of unit root is at a minimum (most negative).

8 Building on the work by Vogelsang (2001), these two authors developed a procedure that would have the same limit distribution in both I(0) and I(1) cases by proposing a new test for structural changes in the trend function of the time series without any prior knowledge of whether the noise component was stationary or integrated.

9 Other shortcomings of these tests have been discussed in Toda and Phillips (1994).

10 As demonstrated by Toda and Yamamoto (1995), if variables are integrated of order d, the usual selection procedure is valid whenever $k\ge d$. Thus, if d = 1, the lag selection is always consistent.

11 A complete description of the hyperparameters of Sims and Zha prior can be found in Brandt and Freedman (2006). For the estimation of the model with a Sims and Zha prior, we use a Normal-Wishart prior distribution. In order to obtain more robust results, we will estimate the model using the KoKo Minnesota/Litterman (1980) prior. The KoKo Minnesota prior assume that the variance is known. Both models are estimated using Bayesian techniques.

12 The lag length criteria suggested 2 lags as the appropriate lag-structure. Note that even though a cointegrating relationship was found, one cannot Granger-test in a VECM environment. For this reason, we use first a VAR to uncover causality implications and then estimate a proper VECM to look at impulse response functions.

Additional information

Notes on contributors

João Tovar Jalles

João Tovar Jalles, a Portuguese national, is an Economist at the Portuguese Public Finance Council. Previously he spent five years at the IMF: one year in the Research Department and four years in the Fiscal Affairs Department. Before joining the Fund, João was the Economist of the Brazil-Portugal Desk at the OECD's Economics Department and before that a Fiscal Economist at the ECB's Fiscal Policies Division. João was also a Visiting Scholar at the IMF's Research Department and a Visiting Researcher at the Bank of Portugal's Research Department. Academically, he was an Invited Lecturer at Sciences Po (France) and Assistant Professor at the University of Aberdeen (UK), and he also taught at the University of Cambridge (UK) and Universidade Nova de Lisboa (Portugal). João's main research areas include fiscal policy and public finance, assessment of forecasting performance, structural reforms, macro-financial linkages and energy economics. He has published more than 80 academic papers in journals such as Journal of Money, Credit and Banking, Oxford Economic Papers, European Journal of Political Economy, International Journal of Forecasting, Journal of Macroeconomics, Economics Letters, Energy Economics, Journal of Forecasting, Macroeconomic Dynamics and European Review of Economic History. He holds a BSc in Economics from Universidade Nova de Lisboa (Portugal), an MSc in Economics from the University of Warwick (UK) and a PhD in Economics from the University of Cambridge (UK).