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Money in Monetary Policy Design: A Formal Characterization of ECB-Style Cross-Checking

  • Guenter W. Beck
  • Volker Wieland

The European Central Bank (ECB) has assigned a special role to money in its two-pillar strategy and has received much criticism for this decision. The case against including money in the central bank's interest rate rule is based on a standard model of the monetary transmission process that underlies many contributions to research on monetary policy in the last two decades. In this paper, we develop a justification for including money in the interest rate rule by allowing for imperfect knowledge regarding unobservables such as potential output and equilibrium interest rates. We formulate a novel characterization of ECB-style monetary cross-checking and show that it can generate substantial stabilization benefits in the event of persistent policy misperceptions regarding potential output. (JEL: E32, E41, E43, E52, E58) (c) 2007 by the European Economic Association.

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Article provided by MIT Press in its journal Journal of the European Economic Association.

Volume (Year): 5 (2007)
Issue (Month): 2-3 (04-05)
Pages: 524-533

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Handle: RePEc:tpr:jeurec:v:5:y:2007:i:2-3:p:524-533
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  1. Stefan Gerlach, 2004. "The two pillars of the European Central Bank," Economic Policy, CEPR;CES;MSH, vol. 19(40), pages 389-439, October.
  2. Katrin Assenmacher-Wesche & Stefan Gerlach, 2007. "Money at Low Frequencies," Journal of the European Economic Association, MIT Press, vol. 5(2-3), pages 534-542, 04-05.
  3. Beck, Günter W. & Wieland, Volker, 2007. "Money in monetary policy design under uncertainty: the Two-Pillar Phillips Curve versus ECB-style cross-checking," Discussion Paper Series 1: Economic Studies 2007,20, Deutsche Bundesbank, Research Centre.
  4. Orphanides, Athanasios & Porter, Richard D. & Reifschneider, David & Tetlow, Robert & Finan, Frederico, 2000. "Errors in the measurement of the output gap and the design of monetary policy," Journal of Economics and Business, Elsevier, vol. 52(1-2), pages 117-141.
  5. Orphanides, Athanasios & Wieland, Volker, 1999. "Inflation zone targeting," Working Paper Series 0008, European Central Bank.
  6. Gerlach, Stefan, 2003. "The ECB's Two Pillars," CEPR Discussion Papers 3689, C.E.P.R. Discussion Papers.
  7. Lars E O Svensson, 1996. "Inflation Forecast Targeting: Implementing and Monitoring Inflation Targets," Bank of England working papers 56, Bank of England.
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