Money Demand Accommodation: Impact on Macro-Dynamics and Policy Consequences

In this paper we account for the U.S. Fed's response to money demand shocks by allowing for less-than-complete accommodation in the estimation of its money supply policy rule. We estimate a significantly lower degree of money accommodation in the 1979-1982 period than before and after. We identify the path of money demand and money supply shocks and show their effects on the money market, output and inflation. Both money demand and money supply shocks have been considerably less destabilizing since 1984. We also find that monetary policy was significantly pro-cyclical in the 70s. Additionally, the price puzzle disappears for two of the three subperiods considered in the study.