Does Money Matter in the IS Curve? The Case of the UK

Abstract

Narrow and broad money measures (including Divisia aggregates) have been found to have explanatory power for UK output in backward-looking specifications of the IS curve. In this paper, we explore whether or not real balances enter into a forward-looking IS curve for the UK, building on the theoretical framework of Ireland (2004). To do this, we test for additive separability between consumption and money over a sizeable part of the post-ERM period using non-parametric methods. If consumption and money are not additively separable, then real money balances enter into the forward-looking IS curve (the converse does not hold, however). A main finding is that the UK data seem to be broadly consistent with additive separability for the more recent period from 1999 to 2007.

Keywords: Additive Separability, IS Curve, Non-Parametric Tests, Measurement Error, Divisia Monetary Aggregates

JEL Classification: C14, C43, C63, E21, E41