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

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  • Beck, Günter W.
  • Wieland, Volker

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 0967.

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Date of creation: Nov 2008
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Handle: RePEc:ecb:ecbwps:20080967

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Keywords: monetary policy under uncertainty; Money; output gap uncertainty; quantity theory; Taylor rules;

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References

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Citations

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Cited by:
  1. Bursian, Dirk & Roth, Markus, 2013. "Optimal policy and taylor rule cross-checking under parameter uncertainty," SAFE Working Paper Series 30, Research Center SAFE - Sustainable Architecture for Finance in Europe, Goethe University Frankfurt.
  2. Orphanides, Athanasios & Wieland, Volker, 2012. "Complexity and monetary policy," CFS Working Paper Series 2012/11, Center for Financial Studies (CFS).
  3. Otmar Issing, 2011. "Lessons for monetary policy: what should the consensus be?," Globalization and Monetary Policy Institute Working Paper 81, Federal Reserve Bank of Dallas.
  4. Wieland, Volker & Beck, Günter W., 2010. "Money in monetary policy design: Monetary cross-checking in the New-Keynesian model," Working Paper Series 1191, European Central Bank.
  5. Issing, Otmar, 2011. "Lessons for monetary policy: What should the consensus be?," CFS Working Paper Series 2011/13, Center for Financial Studies (CFS).
  6. Alfred A. Haug & William G. Dewald, 2010. "Money, Output and Inflation in the Longer Term: Major Industrial Countries, 1880-2001," Working Papers 1013, University of Otago, Department of Economics, revised Sep 2010.
  7. Barthélemy, J. & Clerc L. & Marx, M., 2008. "A Two-Pillar DSGE Monetary Policy Model for the Euro Area," Working papers 219, Banque de France.
  8. Bletzinger, Tilman & Wieland, Volker, 2013. "Estimating the European Central Bank's "Extended Period of Time"," IMFS Working Paper Series 74, Institute for Monetary and Financial Stability (IMFS), Goethe University Frankfurt.
  9. Orphanides, Athanasios, 2010. "Monetary Policy Lessons from the Crisis," CEPR Discussion Papers 7891, C.E.P.R. Discussion Papers.
  10. Matteo Barigozzi & Antonio Conti, 2013. "On the Stability of Euro Area Money Demand and its Implications for Monetary Policy," LEM Papers Series 2013/11, Laboratory of Economics and Management (LEM), Sant'Anna School of Advanced Studies, Pisa, Italy.
  11. Seitz, Franz & Schmidt, Markus A., 2014. "Money in modern macro models: A review of the arguments," OTH im Dialog: Weidener Diskussionspapiere 37, University of Applied Sciences Amberg-Weiden (OTH).
  12. Roth, Markus & Bursian, Dirk, 2012. "Taylor rule cross-checking and selective monetary policy adjustment," Annual Conference 2012 (Goettingen): New Approaches and Challenges for the Labor Market of the 21st Century 62078, Verein für Socialpolitik / German Economic Association.
  13. Schmidt, Sebastian & Wieland, Volker, 2013. "The New Keynesian Approach to Dynamic General Equilibrium Modeling: Models, Methods and Macroeconomic Policy Evaluation," Handbook of Computable General Equilibrium Modeling, Elsevier.
  14. Helge Berger & Henning Weber, 2012. "Money As Indicator for the Natural Rate of Interest," IMF Working Papers 12/6, International Monetary Fund.
  15. Chevapatrakul, Thanaset & Kim, Tae-Hwan & Mizen, Paul, 2012. "Monetary information and monetary policy decisions: Evidence from the euroarea and the UK," Journal of Macroeconomics, Elsevier, vol. 34(2), pages 326-341.
  16. Jens Boysen-Hogrefe, 2014. "Monetary aggregates to improve early output gap estimates in the euro area - an empirical assessment," Kiel Working Papers 1908, Kiel Institute for the World Economy.

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