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Why money growth determines inflation in the long run: answering the Woodford critique

  • Edward Nelson

Woodford (2007) argues that it is not appropriate to regard inflation in the steady state of New Keynesian models as determined by steady-state money growth. Woodford instead argues that the intercept term in the monetary authority's interest-rate policy rule determines steady-state inflation. In this paper, I offer an alternative interpretation of steady-state behavior, according to which it is appropriate to regard steady-state inflation as determined by steady-state money growth. The argument relies on traditional interpretations of the central bank's power in the long run and appeals to model properties that are common to textbook and New Keynesian analysis. According to this argument, the only way the central bank can control interest rates in the long run is via affecting inflation, and its only means available for determining inflation is by determining the money growth rate.

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Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2008-013.

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Date of creation: 2008
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Handle: RePEc:fip:fedlwp:2008-013
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  1. Eric M. Leeper & Jennifer E. Roush, 2003. "Putting "M" back in monetary policy," Proceedings, Federal Reserve Bank of Cleveland, pages 1217-1264.
  2. Samuel Reynard, 2006. "Money and the Great Disinflation," Working Papers 2006-07, Swiss National Bank.
  3. Edward Nelson & Anna J. Schwartz, 2008. "The impact of Milton Friedman on modern monetary economics: setting the record straight on Paul Krugman’s 'Who Was Milton Friedman?," Working Papers 2007-048, Federal Reserve Bank of St. Louis.
  4. McCallum, Bennett T., 1990. "Inflation: Theory and evidence," Handbook of Monetary Economics, in: B. M. Friedman & F. H. Hahn (ed.), Handbook of Monetary Economics, edition 1, volume 2, chapter 18, pages 963-1012 Elsevier.
  5. Peter N. Ireland, 2005. "Changes in the Federal Reserve's inflation target: causes and consequences," Working Papers 05-13, Federal Reserve Bank of Boston.
  6. Nelson, Edward, 2003. "The future of monetary aggregates in monetary policy analysis," Journal of Monetary Economics, Elsevier, vol. 50(5), pages 1029-1059, July.
  7. Ben S. Bernanke & Michael Woodford, 1997. "Inflation Forecasts and Monetary Policy," NBER Working Papers 6157, National Bureau of Economic Research, Inc.
  8. Blinder, Alan S, 1987. "Keynes, Lucas, and Scientific Progress," American Economic Review, American Economic Association, vol. 77(2), pages 130-36, May.
  9. Michael Woodford, 2007. "How Important is Money in the Conduct of Monetary Policy?," NBER Working Papers 13325, National Bureau of Economic Research, Inc.
  10. James Tobin & Willem H. Buiter, 1974. "Long Run Effects of Fiscal and Monetary Policy on Aggregate Demand," Cowles Foundation Discussion Papers 384, Cowles Foundation for Research in Economics, Yale University.
  11. Fernando Alvarez & Robert E. Lucas & Warren E. Weber, 2001. "Interest Rates and Inflation," American Economic Review, American Economic Association, vol. 91(2), pages 219-225, May.
  12. Bennett T. McCallum, 2001. "Monetary policy analysis in models without money," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 145-164.
  13. Assenmacher-Wesche, Katrin & Gerlach, Stefan, 2006. "Money at Low Frequencies," CEPR Discussion Papers 5868, C.E.P.R. Discussion Papers.
  14. Friedman, Milton, 1972. "Comments on the Critics," Journal of Political Economy, University of Chicago Press, vol. 80(5), pages 906-50, Sept.-Oct.
  15. Reynard, Samuel, 2007. "Maintaining low inflation: Money, interest rates, and policy stance," Journal of Monetary Economics, Elsevier, vol. 54(5), pages 1441-1471, July.
  16. 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.
  17. 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.
  18. Darryl R. Francis, 1973. "The usefulness of applied econometrics to the policymaker," Review, Federal Reserve Bank of St. Louis, issue May, pages 7-10.
  19. Nelson, Edward, 2007. "Comment on: Samuel Reynard, "Maintaining low inflation: Money, interest rates, and policy stance"," Journal of Monetary Economics, Elsevier, vol. 54(5), pages 1472-1479, July.
  20. Fiorella De Fiore & Harald Uhlig, 2005. "Bank finance versus bond finance: what explains the differences between US and Europe?," SFB 649 Discussion Papers SFB649DP2005-042, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
  21. Hahn, Frank, 1990. "On Inflation," Oxford Review of Economic Policy, Oxford University Press, vol. 6(4), pages 15-25, Winter.
  22. Blinder, Alan S. & Solow, Robert M., 1973. "Does fiscal policy matter?," Journal of Public Economics, Elsevier, vol. 2(4), pages 319-337.
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