In a recent paper, Friedman and Kuttner (1992) have argued that, independently of how monetary policy is conducted (that is, either committing to an intermediate target, monitoring monetary developments as part of a set of information variables used to formulate feedback rules, or a combination of the two), money can be a helpful variable if it contains information on future developments in output and prices, the variables usually associated with policymakers’ ultimate objectives. This paper follows their approach and uses the VAR methodology to investigate whether movements in money or credit are useful for predicting subsequent movements in output or prices. It then goes on to examine whether the observed empirical relationships in Indonesia, Korea, and the Philippines have changed over time in response to financial sector reforms.
The results are varied and warn against the use of generalizations. In Korea, money was found to contain valuable advance information on output and prices; in the Philippines, to contain information only on the future behavior of prices; and in Indonesia, to contain no advance information. A common test result is that in those cases where some financial aggregate was found to be a significant leading indicator of output or price behavior, a measure of money, narrow or broad, outperformed credit in terms of information content.
Different results were also obtained from the various tests on the effects of financial sector reform on the information content of money. The information content of financial aggregates practically disappeared after the reform in Korea, but was enhanced in the Philippines; money consistently lacked information content in Indonesia. Further tests were conducted in order to assess the information content of exchange and interest rates, variables that gained flexibility with the reforms. Exchange rates were found to contain valuable information about future developments in prices in Korea and the Philippines. Interest rates, in contrast, were found to be significant only in the Philippines; however, in the presence of interest rates no monetary aggregate was significant. These findings strongly suggest that exchange rates could be valuable indicators or guides of monetary policy in these countries.