This paper tests hypotheses regarding the parameters in investors' asset-demand functions. The hypothesis that federal bonds are closer substitutes for equity than for money implies “portfolio crowding out” by federal borrowing. Regression studies of asset-demand functions have needed to impose prior beliefs to obtain precise and plausible estimates for the parameters. This paper uses a MLE technique that dominates regression in that it makes full use of the constraint that the parameters are not determined arbitrarily but rather are determined by mean-variance optimization on the part of the investor. The striking conclusion is that portfolio effects are close to zero.

The term-structure slope contains information about expected future inflation. Mishkin shows that the spread between the twelve-month and three-month interest rates helps predict the difference between twelve-month and three-month inflation. We apply a simple existing framework, which lets the real interest rate vary in the short run but converge to a constant in the long run, to this problem. The appropriate indicator of expected inflation uses the entire length of the yield curve, estimating the steepness of a specific nonlinear transformation, rather than being restricted to a spread between two points. The resulting indicator better predicts inflation, over 1960–1991.

To quantify the implications of common currencies for trade and income, we use data for over 200 countries and dependencies. In our two-stage approach, estimates at the first stage suggest that belonging to a currency union/board triples trade with other currency union members. Moreover, there is no evidence of trade-diversion. Our estimates at the second stage suggest that every one percent increase in a country’s overall trade (relative to GDP) raises income per capita by at least one third of a percent. We combine the two estimates to quantify the effect of common currencies on output. Our results support the hypothesis that important beneficial effects of currency unions come through the promotion of trade.