Isolating Instability In Money Supply Forecasts

Abstract

Previous studies present conflicting evidence on the rationality and efficiency of weekly money supply forecasts.  Many studies have found that these forecasts meet the criteria of the Rational Expectations Hypothesis of unbiasedness, efficiency, and consistency.  However, other research has found biasedness in the 1979-1982 period.  We utilize a battery of tests to assess these criteria for money market survey data from September 1977 through October 1984.  By breaking the available data set into six month subperiods we identify the 1980-1981 period as one of market turbulence producing biased and inefficient money supply forecasts.  This evidence is supported by employing the Brown-Durbin-Evans cusum of squares statistic.  A plot of his statistic indicates structural instability in the relationships tested in 1980.  Factors which may have contributed to this turbulence in 1980 were the Federal Reserve’s shift from an interest rate target to an M1 target in late 1979, the Monetary Control Act of 1980, the imposition of credit controls in 1980, and the volatility in the velocity of M1 in 1980-1981.  Importantly, even though the U.S. monetary environment remained turbulent over the 1979-1982 period, our results show the weekly forecasts of money market dealers reachieving statistical rationality after 1980.