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Stock/Flow Ratios with Money and Debt: What Can Be Learned From the Breakup of Past Relationships in the United States?
Credit and Capital Markets – Kredit und Kapital, Vol. 20 (1987), Iss. 4 : pp. 415–438
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George M. von Furstenberg, Bloomington/Indiana
References
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Abstract
Stock/Flow Ratios With Money and Debt: What Can Be Learned From the Breakup of Past Relationships in the United States?
Because of the apparent stability of velocity relations in the past, noted economists made strong statements earlier this decade about the controllability of nominal GNP by means of financial stock aggregates. As late as 1983, Milton Friedman popularized the function that seemed to explain MI velocity behavior (with Mi taken from 2 quarters earlier than GNP) over the phases of the business cycle. He used this function to expostulate on prospects and policies with great assurance. At about the same time, Benjamin Friedman began to promote a liability aggregate, defined as the total credit market debt of all (private and governmental) domestic nonfinancial sectors. He showed that this concept of debt had been at least as closely related to GNP as the monetary aggregate normally used in velocity relations. In fact, the ratio between debt and GNP had been very nearly trendless over previous decades, showing only very small variations. This and other virtues persuaded Benjamin Friedman to recommend the debt total as an intermediate target in addition to money. While money and debt have moved about as closely together as in earlier decades, everything else changed since. By the end of 1986, the GNP velocities of money and debt had moved between 18 and 32 standard deviations away from the path the different Friedmans might have extrapolated on the basis of (1972 – 82) relations relied upon only a few years earlier. The paper seeks to determine what, beyond the “empirical” argument that “if a rule (or pattern) has always been true in the past it is surely reasonable to suppose that it will continue to hold in the future,” had caused confidence in the predictive significance of these stock-flow relations in the first place. It then analyzes how soon one could have discovered through continuous monitoring of the data that this confidence was misplaced. The remaining question is what to do about targeting once close predictability of the velocities has slipped away.