Strengthening the second pillar: a greater role for money in the ECB’s strategy

Like most central banks, the European Central Bank makes and implements its monetary policy decisions by adjusting its targets for short-term interest rates in response to information gleaned from a wide range of macroeconomic indicators and projections. Unlike other central banks, however, the ECB also monitors money growth as a ‘cross check’ against the macroeconomic analysis that guides its policies of interest rate management. This paper argues that making further use of this ‘second pillar’ would help the ECB to better achieve its nominal objectives in the present environment of exceptionally low interest rates. By modifying the ‘P-star’ framework – a small-scale model with Quantity Theory foundations – the paper shows how the ECB could set a quantitative ‘reference value’ for Divisia money growth to stabilize nominal spending around a target path, even while its traditional interest rate policies are constrained by the zero lower bound.