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Central Bank misperceptions and the role of money in interest rate rules

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Author Info
Guenter W. Beck () (Goethe University Frankfurt, Mertonstrasse 17, D-60325 Frankfurt am Main, Germany.)
Volker Wieland () (Goethe University Frankfurt, Mertonstrasse 17, D-60325 Frankfurt am Main, Germany.)

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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. JEL Classification: E32, E41, E43, E52, E58.

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Paper provided by European Central Bank in its series Working Paper Series with number 967.

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Length: 55 pages
Date of creation: Nov 2008
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Handle: RePEc:ecb:ecbwps:20080967

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

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