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Maintaining low inflation: money, interest rates, and policy stance

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Author Info
Samuel Reynard () (Swiss National Bank, Research Unit, Boersenstrasse 15, 8022 Zurich, Switzerland.)

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Abstract

This paper presents a systematic empirical relationship between money and subsequent prices and output, using US, euro area and Swiss data since the 1960-70s. Monetary developments, unlike interest rate stance measures, are shown to provide qualitative and quantitative information on subsequent inflation. The usefulness of monetary analysis is contrasted to weaknesses in modeling monetary policy and inflation with respectively short-term interest rates and real activity measures. The analysis sheds light on the recent change in inflation volatility and persistence as well as on the Phillips curve flattening, and reveals drawbacks in pursuing a low inflation target without considering monetary aggregates. JEL Classification: E52, E58, E41, E3.

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Paper provided by European Central Bank in its series Working Paper Series with number 756.

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Length: 72 pages
Date of creation: May 2007
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Handle: RePEc:ecb:ecbwps:20070756

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Related research
Keywords: Monetary policy; monetary aggregates; inflation; output; Taylor rule; equilibrium interest rate.;

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This paper has been announced in the following NEP Reports: References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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  2. Reynard, Samuel, 2006. "Money and the Great Disinflation," Working Papers 2006-7, Swiss National Bank. [Downloadable!]
  3. Bennett T. McCallum, 2001. "Monetary Policy Analysis in Models Without Money," NBER Working Papers 8174, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  4. Fernando Alvarez & Andrew Atkeson & Chris Edmond, 2003. "On the Sluggish Response of Prices to Money in an Inventory-Theoretic Model of Money Demand," NBER Working Papers 10016, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  5. John H. Cochrane & Monika Piazzesi, 2002. "Bond Risk Premia," NBER Working Papers 9178, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  6. Athanasios Orphanides, 2003. "Historical monetary policy analysis and the Taylor rule," Finance and Economics Discussion Series 2003-36, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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  7. Stock, James H & Watson, Mark W, 1993. "A Simple Estimator of Cointegrating Vectors in Higher Order Integrated Systems," Econometrica, Econometric Society, vol. 61(4), pages 783-820, July. [Downloadable!] (restricted)
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  8. Timothy Cogley, 1998. "A simple adaptive measure of core inflation," Working Papers in Applied Economic Theory and Econometrics 98-06, Federal Reserve Bank of San Francisco. [Downloadable!]
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  9. Lawrence J. Christiano, 1989. "P*: not the inflation forecaster's holy grail," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 3-18. [Downloadable!]
  10. Gerlach, Stefan & Svensson, Lars E. O., 2003. "Money and inflation in the euro area: A case for monetary indicators?," Journal of Monetary Economics, Elsevier, vol. 50(8), pages 1649-1672, November. [Downloadable!] (restricted)
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  11. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December. [Downloadable!] (restricted)
  12. Hodrick, Robert J & Prescott, Edward C, 1997. "Postwar U.S. Business Cycles: An Empirical Investigation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(1), pages 1-16, February.
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  13. Nelson, Edward, 2003. "The Future of Monetary Aggregates in Monetary Policy Analysis," CEPR Discussion Papers 3897, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  14. Richard Clarida & Jordi Galí & Mark Gertler, 2000. "Monetary Policy Rules And Macroeconomic Stability: Evidence And Some Theory," The Quarterly Journal of Economics, MIT Press, vol. 115(1), pages 147-180, February. [Downloadable!] (restricted)
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  15. Paul De Grauwe & Magdalena Polan, 2005. "Is Inflation Always and Everywhere a Monetary Phenomenon?," Scandinavian Journal of Economics, Blackwell Publishing, vol. 107(2), pages 239-259, 06. [Downloadable!] (restricted)
  16. Thomas Laubach & John C. Williams, 2003. "Measuring the Natural Rate of Interest," The Review of Economics and Statistics, MIT Press, vol. 85(4), pages 1063-1070, November. [Downloadable!] (restricted)
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  17. Andrew Atkeson & Lee E. Ohanian., 2001. "Are Phillips curves useful for forecasting inflation?," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 2-11. [Downloadable!]
  18. John M. Roberts, 2004. "Monetary policy and inflation dynamics," Finance and Economics Discussion Series 2004-62, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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  19. Bennett T. McCallum, 1993. "Unit Roots in Macroeconomic Time Series: Some Critical Issues," NBER Working Papers 4368, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  20. Bennett T. McCallum, 2000. "Alternative Monetary Policy Rules: A Comparison with Historical Settings for the United States, the United Kingdom, and Japan," NBER Working Papers 7725, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  21. Hallman, Jeffrey J & Porter, Richard D & Small, David H, 1991. "Is the Price Level Tied to the M2 Monetary Aggregate in the Long Run?," American Economic Review, American Economic Association, vol. 81(4), pages 841-58, September. [Downloadable!] (restricted)
  22. Poole, William, 1970. "Optimal Choice of Monetary Policy Instruments in a Simple Stochastic Macro Model," The Quarterly Journal of Economics, MIT Press, vol. 84(2), pages 197-216, May. [Downloadable!] (restricted)
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  23. Friedman, Benjamin M & Kuttner, Kenneth N, 1992. "Money, Income, Prices, and Interest Rates," American Economic Review, American Economic Association, vol. 82(3), pages 472-92, June. [Downloadable!] (restricted)
Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Woodford, Michael, 2007. "Does a 'Two-Pillar Phillips Curve' Justify a Two-Pillar Monetary Policy Strategy?," CEPR Discussion Papers 6447, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  2. Karanassou, Marika & Sala, Hector, 2009. "Productivity Growth and the Phillips Curve: A Reassessment of the US Experience," IZA Discussion Papers 4299, Institute for the Study of Labor (IZA). [Downloadable!]
    Other versions:
  3. Edward Nelson, 2008. "Why money growth determines inflation in the long run: answering the Woodford critique," Working Papers 2008-013, Federal Reserve Bank of St. Louis. [Downloadable!]
    Other versions:
  4. Woodford, Michael, 2007. "How Important is Money in the Conduct of Monetary Policy?," CEPR Discussion Papers 6211, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  5. Castelnuovo , Efrem & Greco , Luciano & Raggi, Davide, 2008. "Estimating regime-switching Taylor rules with trend inflation," Research Discussion Papers 20/2008, Bank of Finland. [Downloadable!]
  6. Helge Berger & Thomas Harjes, 2009. "Does Global Liquidity Matter for Monetary Policy in the Euro Area?," IMF Working Papers 09/17, International Monetary Fund. [Downloadable!]
  7. Chris Bloor & Chris Hunt & Tim Ng & Hamish Pepper, 2008. "The use of money and credit measures in contemporary monetary policy," Reserve Bank of New Zealand Bulletin, Reserve Bank of New Zealand, vol. 71, March. [Downloadable!]
  8. Karanassou, Marika & Sala, Hector, 2009. "The US Inflation-Unemployment Tradeoff: Methodological Issues and Further Evidence," IZA Discussion Papers 4252, Institute for the Study of Labor (IZA). [Downloadable!]
    Other versions:
  9. Roman Horvath, 2007. "The Time-Varying Policy Neutral Rate in Real Time: A Predictor for Future Inflation?," Working Papers 2007/4, Czech National Bank, Research Department. [Downloadable!]
    Other versions:
  10. Daniel L. Thornton, 2008. "Monetary policy: why money matters and interest rates don't," Working Papers 2008-011, Federal Reserve Bank of St. Louis. [Downloadable!]
  11. Berger, Helge & Österholm, Pär, 2007. "Does Money Growth Granger-Cause Inflation in the Euro Area? Evidence from Out-of-Sample Forecasts Using Bayesian VARs," Working Paper Series 2007:30, Uppsala University, Department of Economics. [Downloadable!]
    Other versions:
  12. Helge Berger & Emil Stavrev, 2008. "The Information Content of Money in Forecasting Euro Area Inflation," IMF Working Papers 08/166, International Monetary Fund. [Downloadable!]
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