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Doing Without Money: Controlling Inflation in a Post-Monetary World

  • Woodford, Michael

    (Department of Economics, Princeton University)

Central banks now generally agree that conventional monetary aggregates are of little use as targets or even indicators for monetary policy, owing to the instability of money demand relations in economies with well-developed financial markets. But monetary theory has provided little guidance for the analysis of policies that are not formulated in terms of a path for the money supply, and a stable money demand relation is generally assumed as a central element of a theoretical analysis. This paper, instead, shows that it is possible to analyze equilibrium inflation determination without any reference to either money supply or demand, as long as one specifies policy in terms of a 'Wicksellian' interest-rate feedback rule. The paper's central result is an approximation theorem, showing the existence, for a simple monetary model, of a well-behaved 'cashless limit' in which the money balances held to facilitate transactions become negligible. The relations that determine equilibrium inflation in the cashless limit also provide a useful approximate account in the case of an economy in which monetary frictions are present, but small. The approximation remains valid in the case of time variation in the monetary frictions, including variation of a kind that may result in substantial instability of money demand in percentage terms. Inflation in the cashless limit is shown to be a function of the gap between the 'natural rate' of interest, determined by the supply of goods and opportunities for intertemporal substitution, and a time-varying parameter of the interest-rate rule indicating the tightness of monetary policy. Inflation can be completely stabilized, in principle, by adjusting the policy parameter so as to track variation in the natural rate. Under such a regime, instability of money demand has little effect upon equilibrium inflation, and need not be monitored by the central bank.

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Paper provided by Stockholm University, Institute for International Economic Studies in its series Seminar Papers with number 632.

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Length: 62 pages
Date of creation: 06 Nov 1997
Date of revision:
Handle: RePEc:hhs:iiessp:0632
Contact details of provider: Postal: Institute for International Economic Studies, Stockholm University, S-106 91 Stockholm, Sweden
Phone: +46-8-162000
Fax: +46-8-161443
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  1. Woodford, Michael, 1995. "Price-level determinacy without control of a monetary aggregate," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 43(1), pages 1-46, December.
  2. Manuel S. Santos & Michael Woodford, 1997. "Rational Asset Pricing Bubbles," Econometrica, Econometric Society, vol. 65(1), pages 19-58, January.
  3. Estrella, Arturo & Mishkin, Frederic S., 1997. "Is there a role for monetary aggregates in the conduct of monetary policy?," Journal of Monetary Economics, Elsevier, vol. 40(2), pages 279-304, October.
  4. Lucas, Robert E, Jr, 1980. "Equilibrium in a Pure Currency Economy," Economic Inquiry, Western Economic Association International, vol. 18(2), pages 203-20, April.
  5. Robert E. Lucas Jr. & Nancy L. Stokey, 1984. "Money and Interest in Cash-In-Advance Economy," Discussion Papers 628, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  6. Ben S. Bernanke & Frederic S. Mishkin, 1997. "Inflation Targeting: A New Framework for Monetary Policy?," Journal of Economic Perspectives, American Economic Association, vol. 11(2), pages 97-116, Spring.
  7. Woodford, Michael, 1994. "Monetary Policy and Price Level Determinacy in a Cash-in-Advance Economy," Economic Theory, Springer, vol. 4(3), pages 345-80.
  8. Stephanie Schmitt-Grohe & Martin Uribe, 1997. "Price level determinacy and monetary policy under a balanced-budget requirement," Finance and Economics Discussion Series 1997-17, Board of Governors of the Federal Reserve System (U.S.).
  9. McCallum, Bennett T & Nelson, Edward, 1999. "An Optimizing IS-LM Specification for Monetary Policy and Business Cycle Analysis," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(3), pages 296-316, August.
  10. 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.
  11. Svensson, L-E-O, 1996. "Inflation Forecast Targeting : Implementaing and Monitoring Inflation Targets," Papers 615, Stockholm - International Economic Studies.
  12. Wicksell, Knut, 1907. "The Influence of the Rate of Interest on Prices," History of Economic Thought Articles, McMaster University Archive for the History of Economic Thought, vol. 17, pages 213-220.
  13. Obstfeld, Maurice & Rogoff, Kenneth S., 1983. "Speculative Hyperinflations in Maximizing Models: Can We Rule Them Out?," Scholarly Articles 12491027, Harvard University Department of Economics.
  14. Brock, William A., 1975. "A simple perfect foresight monetary model," Journal of Monetary Economics, Elsevier, vol. 1(2), pages 133-150, April.
  15. Hall, R.E. & Mankiw, N.G., 1993. "Nominal Income Targeting," Harvard Institute of Economic Research Working Papers 1650, Harvard - Institute of Economic Research.
  16. Benjamin M. Friedman & Kenneth N. Kuttner, 1996. "A price target for U.S. monetary policy? Lessons from the experience with money growth targets," Working Paper Series, Macroeconomic Issues WP-96-14, Federal Reserve Bank of Chicago.
  17. Sumner, Scott, 1995. "The Impact of Futures Price Targeting on the Precision and Credibility of Monetary Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(1), pages 89-106, February.
  18. Michael Woodford, 1996. "Control of the Public Debt: A Requirement for Price Stability?," NBER Working Papers 5684, National Bureau of Economic Research, Inc.
  19. Mankiw, N. Gregory (ed.), 1997. "Monetary Policy," National Bureau of Economic Research Books, University of Chicago Press, edition 1, number 9780226503097, March.
  20. Julio Rotemberg & Michael Woodford, 1997. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 297-361 National Bureau of Economic Research, Inc.
  21. Sims, Christopher A, 1994. "A Simple Model for Study of the Determination of the Price Level and the Interaction of Monetary and Fiscal Policy," Economic Theory, Springer, vol. 4(3), pages 381-99.
  22. Leeper, Eric M., 1991. "Equilibria under 'active' and 'passive' monetary and fiscal policies," Journal of Monetary Economics, Elsevier, vol. 27(1), pages 129-147, February.
  23. Mervyn King, 1994. "Monetary policy in the UK," Fiscal Studies, Institute for Fiscal Studies, vol. 15(3), pages 109-28, August.
  24. Fuhrer, Jeffrey C & Moore, George R, 1995. "Forward-Looking Behavior and the Stability of a Conventional Monetary Policy Rule," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(4), pages 1060-70, November.
  25. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
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