Economic Stabilization and the Money Supply

In this report the authors discuss two types of short-run deviations in the money supply from a desired growth path: (1) a random shift in the demand for money, which should be accommodated; (2) a deviation reflecting changes in the arguments of the demand-for-money function, which would require an offsetting change in short-term interest rates from the viewpoint of stabilization policy. The focus of the study is on case two. The simulated response of aggregate demand to two such deviations of the same magnitude but differing duration is compared in two models: the latest version of RDX2 and a monetarist reduced-form model. This permits the estimation of a possible range with respect to the magnitude and timing of changes in aggregate spending due to deviations from a desired monetary growth path.