Copulas and the Quantity Theory of Money

Abstract

The quantity theory of money remains a cornerstone of modern macroeconomics that provides a benchmark for the long-run behaviour of macroeconomic models. The direct empirical evidence for it is, however, less conclusive than suggested by scatterplots and the exaggerated correlations between money growth and inflation that can be found in the macroeconomic literature. Copulas with upper tail dependence show a considerably weaker relationship between money growth and inflation than Pearson’s r. Even so, the quantity theory will continue to be part of macroeconomics because economics as a science is driven both by observation and by the inherent structure of the accumulated body of economic theory.

Keywords: copulas, Kendall's tau, quantity theory of money, monetary policy

JEL Classification: C14, C58, E13, E31, E41, E51, E52, E58