ABSTRACT
This chapter evaluates the contribution of the monetary aggregate real M2 and other monetary and financial aggregates to the composite index. In the 1980s, the monetary aggregates became less reliable indicators because their growth rates displayed increased volatility, reduced correspondence to business cycles, and less clearly defined cyclical turning points. The change in the behavior of another real M1 appears to characterize the broader monetary aggregates as well. These changes in behavior are generally attributed to the developments in the financial system that began in the late 1960s and accelerated during the 1970s. In monetary theory, the public’s money balances reflect and help determine aggregate expenditures, while the monetary base affects expenditures, once removed, by helping determine the money supply. While the base represents the outcome of monetary policy actions, it comprises mostly currency, which is supplied on demand and may reflect aggregate activity with a lag and not a lead.
