Advanced Search
MyIDEAS: Login to save this paper or follow this series

Central banks: no reason to ignore money

Contents:

Author Info

  • Scheide, Joachim
Registered author(s):

    Abstract

    The need for a stable monetary policy arises from several facts about business cycles. For example, practically all recessions in industrial countries were preceded by restrictive measures of central, banks. The main cause for the instability, however, was the expansionary policy that led to a boom and too high inflation. There is no question that high inflation in the long run is caused by high money growth; the empirical evidence in favor of the quantity theory of money is overwhelming. Inflation reduces economic growth considerably if it exceeds a certain level. At rates below 10 percent, the negative effects appear to be small. But recent studies show that there is a tremendous welfare gain even if inflation is reduced from a low rate of two percent to zero. This follows from the existence of distorting taxes and from a high demand for non-interest bearing cash at low rates of interest. The conclusion is that zero inflation can be achieved and that it produces a sizable free lunch for a society. While there is a consensus that monetary policy should follow a rule because discretionary policies have a bias towards higher inflation, it is not clear what the best strategy should be. It is often stated that monetary targeting cannot be used in the case of an unstable money demand function. This is not necessarily true because this instability can often be taken account of. Actually, rules exist according to which money growth adjusts to changes in the trend rate of the velocity of money. An instability of the money demand function does not invalidate the policy of monetary targeting or the main predictions of the quantity theory of money. The instability of money demand has led many central banks to pursue inflation targeting instead. But this policy, too, is fundamentally affected if the demand for money is not stable: The strategy requires a forecast for inflation which critically hinges on the conditions on the money market. In the case of an instability, it is difficult or even impossible to predict inflation accurately. This means that inflation targeting may not be better than monetary targeting. According to the Taylor rule, which is often propagated, the central bank reacts to the output gap as well as to the difference between actual inflation and the inflation target. If the central bank wants to set the short-term interest rate accordingly, an estimate for the real equilibrium interest rate is needed. Given the large variations in the trend of real short-term interest rates in the past, it is quite possible that a central bank uses a "wrong" estimate when following the rule. A small underestimation may already produce considerably higher inflation. Such an error is equivalent to the error concerning the estimate of trend velocity in the strategy of monetary targeting, so both strategies may lead to deviations from the target inflation rate. In other words: The Taylor rule is not necessarily superior. The future European Central Bank will choose between monetary targeting and inflation targeting. The start of the European Monetary Union may lead to an instability of the demand for money because of the regime shift. Therefore, the strategy of monetary targeting may lose some of its appeal. However, it does not follow that it is better to pursue a policy of inflation targeting. Any strategy will have difficulties when the fundamental link between money, prices, income and interest rates is disturbed. The rules for monetary policy have desirable features: inflation is to be kept under control, and fluctuations of output are to be reduced. But obviously, there is no single rule which is always and everywhere better than the alternatives. To conclude: It is not justified to disregard monetary targeting — a tendency which seems to prevail among central bankers and economists alike. After all, the quantity theory of money holds well enough to stress the importance of monetary aggregates as an anchor for the price level. --

    Download Info

    If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
    File URL: http://econstor.eu/bitstream/10419/1006/1/243641567.PDF
    Download Restriction: no

    Bibliographic Info

    Paper provided by Kiel Institute for the World Economy (IfW) in its series Kiel Discussion Papers with number 316.

    as in new window
    Length:
    Date of creation: 1998
    Date of revision:
    Handle: RePEc:zbw:ifwkdp:316

    Contact details of provider:
    Postal: Kiellinie 66, D-24105 Kiel
    Phone: +49 431 8814-1
    Fax: +49 431 8814528
    Email:
    Web page: http://www.ifw-kiel.de/
    More information through EDIRC

    Related research

    Keywords:

    References

    References listed on IDEAS
    Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
    as in new window
    1. William Poole, 1969. "Optimal choice of monetary policy instruments in a simple stochastic macro model," Special Studies Papers 2, Board of Governors of the Federal Reserve System (U.S.).
    2. Bennett T. McCallum, 1992. "Specification of Policy Rules and Performance Measures in Multicountry Simulation Studies," IMF Working Papers 92/41, International Monetary Fund.
    3. Robert S. Pindyck & Andres Solimano, 1993. "Economic Instability and Aggregate Investment," NBER Working Papers 4380, National Bureau of Economic Research, Inc.
    4. Lucas, Robert E, Jr, 1996. "Nobel Lecture: Monetary Neutrality," Journal of Political Economy, University of Chicago Press, vol. 104(4), pages 661-82, August.
    5. Bennett T. McCallum, 1993. "Unit Roots in Macroeconomic Time Series: Some Critical Issues," NBER Working Papers 4368, National Bureau of Economic Research, Inc.
    6. Scheide, Joachim, 1989. "A k-percent rule for monetary policy in West Germany," Open Access Publications from Kiel Institute for the World Economy 1396, Kiel Institute for the World Economy (IfW).
    7. Karl-Heinz Todter & Gerhard Ziebarth, 1997. "Price Stability vs. Low Inflation in Germany: An Analysis of Costs and Benefits," NBER Working Papers 6170, National Bureau of Economic Research, Inc.
    8. Martin S. Feldstein, 1997. "The Costs and Benefits of Going from Low Inflation to Price Stability," NBER Chapters, in: Reducing Inflation: Motivation and Strategy, pages 123-166 National Bureau of Economic Research, Inc.
    9. Frank Browne & Gabriel Fagan & Jerome Henry, 2005. "Money Demand in EU Countries: A Survey," Macroeconomics 0503004, EconWPA.
    10. James Tobin, 1977. "How Dead is Keynes?," Cowles Foundation Discussion Papers 458, Cowles Foundation for Research in Economics, Yale University.
    11. Laidler, David, 1991. "The Quantity Theory Is Always and Everywhere Controversial--Why?," The Economic Record, The Economic Society of Australia, vol. 67(199), pages 289-306, December.
    12. Meltzer, Allan H, 1987. "Limits of Short-run Stabilization Policy: Presidential Address to the Western Economic Association, July 3, 1986," Economic Inquiry, Western Economic Association International, vol. 25(1), pages 1-14, January.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as in new window

    Cited by:
    1. Gern, Klaus-Jürgen & Gottschalk, Jan & Kamps, Christophe & Scheide, Joachim & Schlie, Markus & Strauß, Hubert, 1999. "Geringe Dynamik der Weltwirtschaft," Open Access Publications from Kiel Institute for the World Economy 2260, Kiel Institute for the World Economy (IfW).
    2. Schweickert, Rainer, 1998. "Chancen und Risiken eines Currency Board Systems," Open Access Publications from Kiel Institute for the World Economy 1786, Kiel Institute for the World Economy (IfW).
    3. Joachim Scheide & Mathias Trabandt, 2000. "Predicting Inflation in Euroland � The Pstar Approach," Kiel Working Papers 1019, Kiel Institute for the World Economy.
    4. Boss, Alfred & Gern, Klaus-Jürgen & Meier, Carsten-Patrick & Scheide, Joachim & Schlie, Markus, 1999. "Für potentialorientierte Geldpolitik und Steuerwettbewerb in Euroland," Open Access Publications from Kiel Institute for the World Economy 2265, Kiel Institute for the World Economy (IfW).
    5. Kamps, Christophe & Meier, Carsten-Patrick & Scheide, Joachim, 2000. "Euroland: kräftiger Aufschwung, zunehmende Stabilitätsrisiken," Open Access Publications from Kiel Institute for the World Economy 2401, Kiel Institute for the World Economy (IfW).
    6. Gern, Klaus-Jürgen & Meier, Carsten-Patrick & Scheide, Joachim & Schlie, Markus, 1999. "Euroland: Geldpolitik regt Konjunktur an," Open Access Publications from Kiel Institute for the World Economy 2319, Kiel Institute for the World Economy (IfW).

    Lists

    This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

    Statistics

    Access and download statistics

    Corrections

    When requesting a correction, please mention this item's handle: RePEc:zbw:ifwkdp:316. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (ZBW - German National Library of Economics).

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If references are entirely missing, you can add them using this form.

    If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.