RDP 8805: The Relationship Between Financial Indicators and Economic Activity: 1968–1987 6. Financial Indicators and Nominal Private Demand: Correlation Analysis

Michele Bullock, Dirk Morris and Glenn Stevens

August 1988

This section presents correlation coefficients between financial indicators and nominal private demand. It follows the same format as Section 4: part (a) shows results for the full 1968–87 period, while part (b) separates the data into sub-periods.

(a) Full sample results

Table 4 presents correlation coefficients between the range of financial variables and nominal private demand. Results out to a lead of six quarters are reported. This is one quarter more than for real demand because significant coefficients were found at longer leads.

Table 4: Correlation Coefficients Between Financial Variables and Nominal Private Demand
Variable Lead in Quarters (b)
  0 1 2 3 4 5 6
Bill rate −.02 −.10 −.18 −.23** −.26** −.28** −.30**
M1 .02 .19* .34** .39** .39** .32** .26**
M3 .22* .39** .43** .40** .34** .29** .22**
Bank Lending .34** .41** .41** .40** .33** .30** .29**
Broad Money (a) .55** .33** .29* .15 .09 .09 −.01
Lending (a) .46** .22 .12 .06 .08 .03 .03
Credit (a) .34** .16 .07 .04 .07 .02 −.06
(a) The estimation period for these variables is from 1976–87. The others are for the full sample, 1968–87. All financial aggregates and demand are quarterly percentage changes.
(b) An asterisk indicates significance at the 10 per cent level; two indicates the 5 per cent level.

For interest rates, all significant coefficients are negative, as expected. In other words, a rise in the short-term interest rate is generally associated with a fall in nominal demand, a result consistent with those found using real demand. The important difference is that there is no coincident relationship, and no relationship at leads 1 and 2, and that the coefficients at leads 5 and 6 are now significant. That is, 2, and that the coefficients at leads 5 and 6 are now significant. That is, the lead length is extended by 2–3 quarters compared with the results for real demand.

The picture is similar for M1. There are strong positive correlations with nominal demand, beginning at the second lead, and continuing to the sixth lead.

For M3 and bank lending, the results are much stronger than they are for real demand. They also show larger coefficients on M3 as compared with interest rates and M1. There are large and significant positive coefficients running from zero to six quarter leads for both M3 and bank lending.

Broad money has a significant positive correlation with nominal demand, which is the strongest in the current quarter and extends to lead 2. This significant leading role for broad money contrasts with its relationship to real demand, where the only significant positive correlation was the coincident one.

Lending and credit have very similar correlation patterns. The current coefficients are both positive and significant, (unlike the results using real demand) but no leading coefficients are significant. Table 5 shows correlations tween the financial indicators and nominal demand when the financial indicators are allowed to lag demand. It suggests that the broader lending and credit aggregates do lag nominal demand.

Table 5: Correlation Coefficients Between Financial Indicators and Nominal Private Demand
Indicator lag in quarters(b)
  1 2 3 4 5
Bill rate .05 .10 .11 .10 .06
M1 −.13 −.23** −.23** −.21* −.16
M3 .09 −.03 −.11 −.09 −.08
Bank lending .24** .15 .03 −.04 −.13
Broad Money (a) .44** .17 −.02 −.18 −.30**
Lending (a) .51** .40** .19 −.05 −.26*
Credit (a) .40** .32** .12 −.12 −.34**

(a) The estimation period for these variables is from 1976–87. The others are for the full sample, 1968–87. All financial aggregates and demand are quarterly percentage changes.
(b) An asterisk indicates significance at the 10 per cent level; two indicates the 5 per cent level.

In comparing the correlation results above to those for real demand, it appears that the lead time is longer for those variables which lead demand and that the lag time is shorter for those which lag demand.

(b) Variation Between Sub-Periods

Table 6 presents the sub-sample correlation coefficients for the financial indicators and nominal private demand. In the first sub-period, interest rates have a strong positive relationship with nominal demand, both coincidentally and over the six leading quarters. These results are in stark contrast to the full sample (and to the results for real demand). But they are consistent with the graphical evidence, which showed an apparent positive association of interest rates with nominal demand during the early 1970s. It is likely that the strength of this association, given the very large movements in both the series, dominates the correlation result.

Table 6: Correlation Coefficients Between Financial Indicators and Nominal Private Demand: Selected Sub-Periods
Indicator Sub-periods(a)
  Lead in
Quarters		 Mar 1968 to
Dec. 1980		 Dec. 1980 to
Dec. 1987		 Dec. 1983 to
Dec. 1987
Bill rate 0 .39** .41** .12
  1 .36** .06 −.16
  2 .31** −.28 −.51**
  3 .32** −.53** −.71**
  4 .32** −.69** −.70**
  5 .33** −.75** −.63**
  6 .31** −.70** −.54**
M1 0 .14 −.37* −.49*
  1 .24* −.01 −.08
  2 .30** .37** .38
  3 .33** .45** .37
  4 .29** .55** .25
  5 .24 .46** .12
  6 .19 .34* −.01
M3 0 .30** .00 .36
  1 .47** .18 .74**
  2 .50** .32* .71**
  3 .49** .19 .33
  4 .45** .08 −.00
  5 .38** .09 −.20
  6 .34** −.12 −.38
Bank Lending 0 .43** .17 .37
  1 .54** .14 .36
  2 .55** .08 .24
  3 .57** −.11 −.12
  4 .52** −.25 −.49*
  5 .49** −.26 −.62**
  6 .49** −.31 −.72**
Broad Money 0 – .52** .64**
  1 – .52** .48*
  2 – .51** .38
  3 – .33* .25
  4 – .23 .08
  5 – .09 −.11
  6 – −.20 −.48*
Lending 0 – .59** .49*
  1 – .52** .23
  2 – .35** .05
  3 – .13 −.08
  4 – .03 −.15
  5 – −.13 −.33
  6 – −.26 −.54**
Credit 0 – .48** .25
  1 – .45** .15
  2 – .34* .08
  3 – .18 .03
  4 – .06 −.04
  5 – −.16 −.29
  6 – −.30 −.59**

(a) An asterisk indicates significance at the 10 per cent level; two indicates the 5 per cent level.

This is confirmed by results for the 1980–87 period. In this latter period, only the coincident coefficient remains positive and significant, while the coefficients from leads 3 to 6 are negative. In the 1983–87 period, coefficients for leads 2 to 6 are negative and significant, and the coincident coefficient is insignificantly different from zero. This latter relationship is sufficiently strong to dominate the correlation results for the full sample period[16]

The results for M1 also show noticeable changes in coefficients. The expected positive relationship between M1 and nominal demand is evident in the 1968–1980 sample for leads 1 to 4. The lag structure for the positive relationship lengthens in the 1980–87 period, and the coincident coefficient becomes negative. But in the 1983–87 period, the only significant relationship is a coincident, and negative one.[17]

For M3 and bank lending the strong, positive and leading relationship observed in the full sample is shown to be largely a reflection of the 1968–80 sub-period[18]. In the 1980–87 period, none of the coefficients were significant. The coincident and first two leading coefficients became significant in the 1983–87 period for M3, but for bank lending the only significant coefficients were of the wrong (negative) sign.

Broad money, lending and credit showed a leading relationship in the 1980–87 period, with the coincident and first two or three leading coefficients positive and significant in each case. But this was largely a result of the pre-December 1983 period, and the relationship deteriorated in the 1983–87 period. Each indicator lost a couple of significant leading coefficients, and credit did not have any significant positive coefficients at all. Each of the broad aggregates has a significant coefficient of the wrong (negative) sign at lead 6.

Footnotes

The negative leading relationship between interest rates and nominal GDP in the post-1983 period is not as strong. [16]

Here again the results are sensitive to the choice of indicator for activity. The use of nominal GDP provides a significant positive relationship at the first quarter lead for M1. [17]

More detailed analysis (not reported here) suggests that the long leading relationship in the full sample is largely determined by the data in the late 1960's and early 1970's. [18]