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A Note on Money and the Conduct of Monetary Policy

  • Jagjit S. Chadha
  • Luisa Corrado
  • Sean Holly

Prior to the financial crisis mainstream monetary policy practice had become disconnected from money. We outline the basic rationale for this development using a simple model of money and credit in which we explore the conditions under which money matters directly for the conduct of policy. Then, drawing on Goodfriend and McCallum’s (2007) DSGE model, we examine the circumstances under which money becomes more closely linked to inflation. We find that money matters when the variance of the supply of lending dominates productivity and the velocity of money demand. This is because amplifying the role of loans supply leads to an expansion in aggregate demand, via a compression of the external finance premium, which is inflationary. We consider a number of alternative monetary policy rules, and find that a rule which exploits the joint information from money and the external finance premium performs best.

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Paper provided by Faculty of Economics, University of Cambridge in its series Cambridge Working Papers in Economics with number 1329.

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Date of creation: 28 Aug 2013
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Handle: RePEc:cam:camdae:1329
Contact details of provider: Web page: http://www.econ.cam.ac.uk/index.htm

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  1. Chadha, Jagjit S. & Nolan, Charles, 2007. "Optimal simple rules for the conduct of monetary and fiscal policy," Journal of Macroeconomics, Elsevier, vol. 29(4), pages 665-689, December.
  2. S. Boragan Aruoba & Frank Schorfheide, 2009. "Sticky prices versus monetary frictions: an estimation of policy trade-offs," Working Papers 09-8, Federal Reserve Bank of Philadelphia.
  3. Reynard, Samuel, 2007. "Maintaining low inflation: money, interest rates, and policy stance," Working Paper Series 0756, European Central Bank.
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  5. Stracca, Livio, 2013. "Inside Money In General Equilibrium: Does It Matter For Monetary Policy?," Macroeconomic Dynamics, Cambridge University Press, vol. 17(03), pages 563-590, April.
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  7. Favara, Giovanni & Giordani, Paolo, 2002. "Reconsidering the Role of Money for Output, Prices and Interest Rates," SSE/EFI Working Paper Series in Economics and Finance 514, Stockholm School of Economics.
  8. V. V. Chari & Lawrence J. Christiano & Martin Eichenbaum, 1995. "Inside Money, Outside Money and Short Term Interest Rates," NBER Working Papers 5269, National Bureau of Economic Research, Inc.
  9. Nelson, Edward, 2001. "Direct Effects of Base Money on Aggregate Demand: Theory and Evidence," CEPR Discussion Papers 2666, C.E.P.R. Discussion Papers.
  10. Chadha, J.S. & Corrado, L. & Sun, Q., 2008. "Money, Prices and Liquidity Effects: Separating Demand from Supply," Cambridge Working Papers in Economics 0855, Faculty of Economics, University of Cambridge.
  11. Jonathan Chiu & Cesaire Meh, 2008. "Financial Intermediation, Liquidity and Inflation," Working Papers 08-49, Bank of Canada.
  12. Peter N. Ireland, 2001. "Money's Role in the Monetary Business Cycle," NBER Working Papers 8115, National Bureau of Economic Research, Inc.
  13. William Poole, 1970. "Optimal choice of monetary policy instruments in a simple stochastic macro model," Staff Studies 57, Board of Governors of the Federal Reserve System (U.S.).
  14. Vasco Cúrdia & Michael Woodford, 2009. "Credit Spreads and Monetary Policy," NBER Working Papers 15289, National Bureau of Economic Research, Inc.
  15. Jagjit S Chadha & Luisa Corrado & Jack Meaning, 2012. "Reserves, liquidity and money: an assessment of balance sheet policies," BIS Papers chapters, in: Bank for International Settlements (ed.), Are central bank balance sheets in Asia too large?, volume 66, pages 294-347 Bank for International Settlements.
  16. Meier, André & Müller, Gernot J., 2005. "Fleshing out the monetary transmission mechanism: output composition and the role of financial frictions," Working Paper Series 0500, European Central Bank.
  17. Benk, Szilárd & Gillman, Max & Kejak, Michal, 2005. "Credit Shocks in the Financial Deregulatory Era: Not the Usual Suspects," Cardiff Economics Working Papers E2005/13, Cardiff University, Cardiff Business School, Economics Section.
  18. Lawrence Christiano & Roberto Motto & Massimo Rostagno, 2007. "Two Reasons Why Money and Credit May be Useful in Monetary Policy," NBER Working Papers 13502, National Bureau of Economic Research, Inc.
  19. Blanchard, Olivier Jean & Kahn, Charles M, 1980. "The Solution of Linear Difference Models under Rational Expectations," Econometrica, Econometric Society, vol. 48(5), pages 1305-11, July.
  20. Charles Goodhart, 2007. "Whatever became of the Monetary Aggregates?," FMG Special Papers sp172, Financial Markets Group.
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