Financial Sector Weakness and the M2 Velocity Puzzle

Posted: 29 Feb 2008

See all articles by Cara S. Lown

Cara S. Lown

Federal Reserve Banks - Federal Reserve Bank of New York

Stavros Peristiani

Federal Reserve Bank of New York--Retired

Kenneth J. Robinson

Federal Reserve Bank of Dallas

Date Written: October 2006

Abstract

Deterioration in the link between M2 and GDP, along with large prediction errors, led the Federal Reserve to downgrade M2 as a reliable indicator in 1993. We argue that the financial condition of depository institutions was a major factor behind this unusual pattern of M2 growth. When constructing measures of M2 based on banks' and thrifts' capital positions, we obtain superior M2 forecasting results and a more stable relationship between M2 and the ultimate goals of policy. M2 may contain useful information when there are no major disturbances to depository institutions.

JEL Classification: E4, E5, G2

Suggested Citation

Lown, Cara S. and Peristiani, Stavros and Robinson, Kenneth J., Financial Sector Weakness and the M2 Velocity Puzzle (October 2006). Economic Inquiry, Vol. 44, Issue 4, pp. 699-715, 2006, Available at SSRN: https://ssrn.com/abstract=1095971 or http://dx.doi.org/10.1093/ei/cbl009

Cara S. Lown (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045-0001
United States
212-720-1232 (Phone)

Stavros Peristiani

Federal Reserve Bank of New York--Retired ( email )

3001 Henry Hudson Pkwy W
Apartment 1C
Bronx, NY New York 10463
United States
718-796-5190 (Phone)

Kenneth J. Robinson

Federal Reserve Bank of Dallas ( email )

PO Box 655906
Dallas, TX 75265-5906
United States
214-922-5365 (Phone)
214-922-5351 (Fax)

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