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Central Bank Misperceptions and the Role of Money in Interest Rate Rules

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Author Info
Beck, Günter
Wieland, Volker

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Abstract

Research with Keynesian-style models has emphasized the importance of the output gap for policies aimed at controlling inflation while declaring monetary aggregates largely irrelevant. Critics, however, have argued that these models need to be modified to account for observed money growth and inflation trends, and that monetary trends may serve as a useful cross-check for monetary policy. We identify an important source of monetary trends in form of persistent central bank misperceptions regarding potential output. Simulations with historical output gap estimates indicate that such misperceptions may induce persistent errors in monetary policy and sustained trends in money growth and inflation. If interest rate prescriptions derived from Keynesian-style models are augmented with a cross-check against money-based estimates of trend inflation, inflation control is improved substantially.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 6947.

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Date of creation: Aug 2008
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Handle: RePEc:cpr:ceprdp:6947

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Related research
Keywords: monetary policy under uncertainty; money; output gap uncertainty; quantity theory; Taylor rules;

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Find related papers by JEL classification:
E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Determination of Interest Rates; Term Structure of Interest Rates
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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