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On the role of money growth targeting under inflation targeting regime

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  • Dai, Meixing

Abstract

The mainstream inflation-targeting literature makes the strong assumption that the central bank can exactly target the interest rate which affects investment and consumption decisions and hence the money supply plays no role in the monetary policy strategy. This assumption is equivalent to admitting the perfect credibility of inflation target announced by the central bank, the perfect functioning of money and financial markets and that the central bank is willing to inject as much liquidity as the economic agents demand. Neither of these assumptions corresponds to the reality. In effect, the inflation expectations can not be easily anchored by the cheap talk of central bankers. On the other hand, the central bank may have many difficulties to target, in a context of financial instability, the interest rates which affect the real and financial decisions of private agents. We suggest that under inflation-targeting regime, money and credit markets vehicle the inflation expectations that can be anchored with a well-specified feedback money growth rule. The latter, in contrast to the Friedman’s k percent money growth rule, can help managing the inflation expectations in a manner to guarantee the dynamic stability of the economy. Furthermore, the model can be easily used to discuss the implications of the zero interest rate policy and the quantitative easing policy.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 13780.

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Date of creation: 20 Feb 2009
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Handle: RePEc:pra:mprapa:13780

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Keywords: Interest rate rule; imperfect money and credit markets; inflation targeting; monetary targeting; inflation expectations; Friedman’s k percent money growth rule; feedback money growth rule; macroeconomic stability; zero interest rate policy; quantitative easing policy;

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