TY - JOUR AU - Feldstein,Martin AU - Stock,James H. TI - The Use of Monetary Aggregate to Target Nominal GDP JF - National Bureau of Economic Research Working Paper Series VL - No. 4304 PY - 1993 Y2 - March 1993 UR - http://www.nber.org/papers/w4304 L1 - http://www.nber.org/papers/w4304.pdf N1 - Author contact info: Martin S. Feldstein President Emeritus NBER 1050 Massachusetts Avenue Cambridge, MA 02138-5398 Tel: 617/868-3905 Fax: 617/868-7194 E-Mail: msfeldst@nber.org James H. Stock Department of Economics Harvard University Littauer Center M27 Cambridge, MA 02138 Tel: 617/496-0502 Fax: 617/495-7730 E-Mail: James_Stock@harvard.edu M1 - published as Martin Feldstein, James H. Stock. "The Use of a Monetary Aggregate to Target Nominal GDP," in N. Gregory Mankiw, ed., "Monetary Policy" The University of Chicago Press (1994) M2 - featured in NBER digest on 1993-06-01 AB - This paper studies the possibility of using the broad monetary aggregate M2 to target the quarterly rate of growth of nominal GDP. Our findings indicate that the Federal Reserve could probably guide M2 in a way that reduces not only the long-term average rate of inflation but also the variance of the annual rate of growth of nominal GDP. An optimal M2 rule, derived from a simple VAR, reduces the mean ten-year standard deviation of annual GDP growth by over 20 percent. Although there is uncertainty about this value because of both parameter uncertainty and stochastic shocks to the economy, we estimate that the probability that the annual variance would be reduced over a ten year period exceeds 85 percent. A much simpler policy based on a single equation linking M2 and GDP is shown to be almost as successful in reducing this annual GDP variance. Additional statistical tests indicate that M2 is a useful predictor of nominal GDP. Moreover, a battery of recently developed tests for parameter stability fails to reject the hypothesis that the M2 - GDP link is stable, but the MI - GDP and monetary base - GDP relations are found to be highly unstable. This evidence contradicts those who have argued that the M2 - GDP relation is so unstable in the short run that it cannot be used to reduce the variance of nominal GDP growth. ER -