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Doing Without Money: Controlling Inflation in a Post-Monetary World

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  • Woodford, Michael

    (Department of Economics, Princeton University)

Abstract

Central banks now generally agree that conventional monetary aggregates are of little use as targets or even indicators for monetary policy, owing to the instability of money demand relations in economies with well-developed financial markets. But monetary theory has provided little guidance for the analysis of policies that are not formulated in terms of a path for the money supply, and a stable money demand relation is generally assumed as a central element of a theoretical analysis. This paper, instead, shows that it is possible to analyze equilibrium inflation determination without any reference to either money supply or demand, as long as one specifies policy in terms of a 'Wicksellian' interest-rate feedback rule. The paper's central result is an approximation theorem, showing the existence, for a simple monetary model, of a well-behaved 'cashless limit' in which the money balances held to facilitate transactions become negligible. The relations that determine equilibrium inflation in the cashless limit also provide a useful approximate account in the case of an economy in which monetary frictions are present, but small. The approximation remains valid in the case of time variation in the monetary frictions, including variation of a kind that may result in substantial instability of money demand in percentage terms. Inflation in the cashless limit is shown to be a function of the gap between the 'natural rate' of interest, determined by the supply of goods and opportunities for intertemporal substitution, and a time-varying parameter of the interest-rate rule indicating the tightness of monetary policy. Inflation can be completely stabilized, in principle, by adjusting the policy parameter so as to track variation in the natural rate. Under such a regime, instability of money demand has little effect upon equilibrium inflation, and need not be monitored by the central bank.

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Bibliographic Info

Paper provided by Stockholm University, Institute for International Economic Studies in its series Seminar Papers with number 632.

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Length: 62 pages
Date of creation: 06 Nov 1997
Date of revision:
Handle: RePEc:hhs:iiessp:0632

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Postal: Institute for International Economic Studies, Stockholm University, S-106 91 Stockholm, Sweden
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Web page: http://www.iies.su.se/
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Keywords: interest-rate feedback; cashless limit;

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  1. Robert E. Lucas Jr. & Nancy L. Stokey, 1984. "Money and Interest in Cash-In-Advance Economy," Discussion Papers, Northwestern University, Center for Mathematical Studies in Economics and Management Science 628, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  2. Woodford, Michael, 1995. "Price-level determinacy without control of a monetary aggregate," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 43(1), pages 1-46, December.
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  7. Maurice Obstfeld & Kenneth Rogoff, 1982. "Speculative Hyperinflations in Maximizing Models: Can We Rule Them Out?," NBER Working Papers 0855, National Bureau of Economic Research, Inc.
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