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Should Monetary Policy Respond to Money Growth? New Results for the Euro Area

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  • Michael Scharnagl
  • Christina Gerberding
  • Franz Seitz

Abstract

In recent years, the relevance of money growth indicators for the conduct of monetary policy has been questioned in the mainstream academic literature. It is widely argued that monetary policy should directly relate short-term interest rates to inflation and the output gap. The present paper investigates whether the performance of this type of interest rate rule can be significantly improved by adding a policy response to money growth. In contrast to most previous studies, our analysis explicitly takes into account the fact that real‐time data on both actual and potential output, and hence the output gap, may be subject to substantial measurement errors. Broadly speaking, we find that the greater the degree of output gap uncertainty, the greater the benefits of incorporating a money growth response are in terms of reducing volatility in output, inflation and interest rates. The main reason is that real‐time data on money growth contain valuable information on the true level of current output growth, which is not otherwise known to policy makers in real time with a sufficient degree of precision. Hence, we conclude that policy makers should explicitly account for money growth in the setting of policy rates.

Suggested Citation

  • Michael Scharnagl & Christina Gerberding & Franz Seitz, 2010. "Should Monetary Policy Respond to Money Growth? New Results for the Euro Area," International Finance, Wiley Blackwell, vol. 13(3), pages 409-441, Winter.
  • Handle: RePEc:bla:intfin:v:13:y:2010:i:3:p:409-441
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    File URL: http://hdl.handle.net/10.1111/j.1468-2362.2010.01267.x
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    References listed on IDEAS

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    Cited by:

    1. Pierre-Richard Agénor & Luiz A. Pereira da Silva, 2013. "Inflation Targeting and Financial Stability: A Perspective from the Developing World," Working Papers Series 324, Central Bank of Brazil, Research Department.
    2. 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.
    3. Jens Boysen‐Hogrefe, 2015. "Monetary Aggregates to Improve Early Output Gap Estimates in the Euro Area: An Empirical Assessment," Journal of Forecasting, John Wiley & Sons, Ltd., vol. 34(7), pages 533-542, November.
    4. Otmar Issing, 2011. "Lessons for Monetary Policy; What Should the Consensus Be?," IMF Working Papers 11/97, International Monetary Fund.
    5. Franz Seitz & Markus A. Schmidt, 2014. "Money In Modern Macro Models: A Review of the Arguments," Journal of Reviews on Global Economics, Lifescience Global, vol. 3, pages 156-174.
    6. Helge Berger & Henning Weber, 2012. "Money As Indicator for the Natural Rate of Interest," IMF Working Papers 12/6, International Monetary Fund.
    7. Issing, Otmar, 2011. "Lessons for monetary policy: What should the consensus be?," CFS Working Paper Series 2011/13, Center for Financial Studies (CFS).
    8. Arto Kovanen, 2011. "Does Money Matter for Inflation in Ghana?," IMF Working Papers 11/274, International Monetary Fund.

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