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Assessing Money Supply Rules

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  • Ibrahim Chowdhury
  • Andreas Schabert

Abstract

We provide evidence that Federal Reserve’s money supply can be characterized by a simple rule, whereby the growth rate of nonborrowed reserves depends on expected in‡ation. The Volcker-Greenspan era is found to be associated with a negative in‡ation elasticity, whereas our estimates indicate that the Federal Reserve in the pre-1980 era supplied money in an accommodating way. While these results appear to be consistent with empirical evidence on interest rate rules, our theoretical analysis gives rise to novel insights. Applying a New Keynesian model, money supply rules are shown to ensure saddle path stabil-ity, indicating that they do not allow for self-fulling expectations. Further, optimal monetary policy canbeimplementedby a money supplyrule witha negative in‡ation elasticity, implying that the pre-1980 regime was less e¢cient in dampening macroeconomic ‡uctuations. On the transmission of money sup-ply shocks, we show that a negative in‡ation elasticity raises the likelihood of a liquidity e¤ect and lowers the persistence of the output response.

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Bibliographic Info

Paper provided by Business School - Economics, University of Glasgow in its series Working Papers with number 2003_9.

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Date of revision: May 2003
Handle: RePEc:gla:glaewp:2003_9

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