A THEORETICAL AND EMPIRICAL INVESTIGATION INTO THE REAL EFFECTS OF ANTICIPATED AND UNANTICIPATED CHANGES IN THE MONEY GROWTH RATE (CANADA, GERMANY, UNITED KINGDOM, UNITED STATES)

In this dissertation, the neutrality of anticipated and unanticipated changes in the money growth rate and the rationality of expectations are examined both theoretically and empirically. The theoretical model is used to demonstrate that the assumption of rational expectations does not necessarily imply that changes in the money growth rate are neutral. In the model developed in this dissertation, it is assumed that expectations are formed rationally and the result that both anticipated and unanticipated changes in the rate of growth of the money stock can cause changes in real output is obtained. Based upon this theoretical result, empirical investigations into the rationality of expectations and the neutrality of changes in the money growth rate performed in the past are evaluated. It is argued that the empirical output equations employed in these investigations are misspecified, and that tests of the rationality and neutrality hypotheses are performed under an inappropriate set of restrictions.

These problems do not occur in the empirical work performed here. An empirical output equation that is consistent with the theoretical results is specified and shown to result in valid tests of the rationality and neutrality hypotheses. This new empirical model is estimated for each of the four countries Canada, Germany, the United Kingdom, and the United States, and tests of the rationality and neutrality hypotheses are performed for each country. The results of these tests strongly support both the rationality of expectations and the non-neutrality of anticipated changes in the money growth rate. Additionally, the results are robust to changes in the assumed lag length of the exogenous variables appearing in the empirical output equation and thus avoid a problem evidenced in other empirical investigations into these issues.