Alternative Operating Procedures for Monetary Policy - A New Look at the Money Supply Process

This paper develops a new framework for the process of money supply. In contrast to models like McCallum (1989) based on the money multiplier analysis or the credit market models of Brunner and Meltzer (1966, 1973) our model explicitly illustrates the interaction of non-banks, banks and the central bank on the two relevant markets: the market for central bank money and the market for bank credit (which is identical to the macroeconomic 'money market'). Special emphasis is placed on the role of the central bank and its alternative control procedures for the supply of base money: targeting the central bank rate or the quantity of high-powered money. It is shown that within the concept of monetary targeting the choice of the optimal control procedure critically depends on the relative strength of different shocks: if disturbances on the credit market dominate, monetary base targeting is to be preferred; conversely, if money multiplier shocks dominate, interest rate targeting should be favoured.