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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
Date of revision:
Handle: RePEc:fip:fedlwp:2008-013
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  1. Favara, Giovanni & Giordani, Paolo, 2009. "Reconsidering the role of money for output, prices and interest rates," Journal of Monetary Economics, Elsevier, vol. 56(3), pages 419-430, April.
  2. Samuel Reynard, 2006. "Money and the Great Disinflation," Working Papers 2006-07, Swiss National Bank.
  3. 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.
  4. Samuel Reynard, 2007. "Maintaining Low Inflation: Money, Interest Rates, and Policy Stance," Working Papers 2007-05, Swiss National Bank.
  5. 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.
  6. Fernando Alvarez & Robert E. Lucas & Warren E. Weber, 2001. "Interest rates and inflation," Working Papers 609, Federal Reserve Bank of Minneapolis.
  7. De Fiore, Fiorella & Uhlig, Harald, 2005. "Bank finance versus bond finance: what explains the differences between US and Europe?," Working Paper Series 0547, European Central Bank.
  8. Eric M. Leeper & Jennifer E. Roush, 2003. "Putting "M" back in monetary policy," Proceedings, Federal Reserve Bank of Cleveland, pages 1217-1264.
  9. Woodford, Michael, 2007. "How Important is Money in the Conduct of Monetary Policy?," CEPR Discussion Papers 6211, C.E.P.R. Discussion Papers.
  10. Nelson, Edward, 2003. "The future of monetary aggregates in monetary policy analysis," Journal of Monetary Economics, Elsevier, vol. 50(5), pages 1029-1059, July.
  11. Bernanke, Ben S & Woodford, Michael, 1997. "Inflation Forecasts and Monetary Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(4), pages 653-84, November.
  12. Darryl R. Francis, 1973. "The usefulness of applied econometrics to the policymaker," Review, Federal Reserve Bank of St. Louis, issue May, pages 7-10.
  13. Hahn, Frank, 1990. "On Inflation," Oxford Review of Economic Policy, Oxford University Press, vol. 6(4), pages 15-25, Winter.
  14. Nelson, Edward & Schwartz, Anna J., 2008. "The impact of Milton Friedman on modern monetary economics: Setting the record straight on Paul Krugman's "Who was Milton Friedman?"," Journal of Monetary Economics, Elsevier, vol. 55(4), pages 835-856, May.
  15. Friedman, Milton, 1972. "Comments on the Critics," Journal of Political Economy, University of Chicago Press, vol. 80(5), pages 906-50, Sept.-Oct.
  16. Peter N. Ireland, 2007. "Changes in the Federal Reserve's Inflation Target: Causes and Consequences," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(8), pages 1851-1882, December.
  17. Blinder, Alan S. & Solow, Robert M., 1973. "Does fiscal policy matter?," Journal of Public Economics, Elsevier, vol. 2(4), pages 319-337.
  18. 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.
  19. Bennett T. McCallum, 2001. "Monetary Policy Analysis in Models Without Money," NBER Working Papers 8174, National Bureau of Economic Research, Inc.
  20. 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.
  21. 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.
  22. Blinder, Alan S, 1987. "Keynes, Lucas, and Scientific Progress," American Economic Review, American Economic Association, vol. 77(2), pages 130-36, May.
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