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Is money supply targeting obsolete?

  • Langfeldt, Enno
  • Scheide, Joachim
  • Trapp, Peter
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    Money supply targeting has come out of fashion. The large changes in velocity in some countries and the fact that inflation is still low in spite of the strong monetary expansion in most industrial economies since 1985 have undermined the formerly accepted notion of a stable relationship between money and economic activity. In this paper, the most important objections to money supply targeting are discussed. Furthermore, alternative indicators for monetary policy, e.g., interest rates and raw material prices, are analyzed; they seem to have serious weaknesses. A closer look at the relationship between money and economic activity reveals that in most countries the volatility of velocity is no more pronounced than in earlier years. Only in a few countries the relationship is disturbed. However, this is largely due to changes in the financial system which were partly caused by high and volatile inflation rates. Therefore, we argue that a case for monetary rules can still be made. Some rules which have been proposed in the literature are designed to adjust to trend changes in velocity. Simulations suggest that if central banks had followed such rules, economic performance would have improved substantially. We conclude that it would be desirable to implement a rule-based policy in industrial countries and suggest that rules should be enforced by law.

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    Paper provided by Kiel Institute for the World Economy in its series Kiel Working Papers with number 338.

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    Date of creation: 1988
    Handle: RePEc:kie:kieliw:338
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    1. Jean-Claude Chouraqui & Michael Driscoll & Marc-Olivier Strauss-Kahn, 1988. "The Effects of Monetary Policy on the Real Sector: An Overview of Empirical Evidence for Selected OECD Economies," OECD Economics Department Working Papers 51, OECD Publishing.
    2. Milton Friedman, 1961. "The Lag in Effect of Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 69, pages 447-447.
    3. Meltzer, Allan H, 1987. "Limits of Short-run Stabilization Policy: Presidential Address to the Western Economic Association, July 3, 1986," Economic Inquiry, Western Economic Association International, vol. 25(1), pages 1-14, January.
    4. McKinnon, Ronald I, 1988. "Monetary and Exchange Rate Policies for International Financial Stability: A Proposal," Journal of Economic Perspectives, American Economic Association, vol. 2(1), pages 83-103, Winter.
    5. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-491, June.
    6. Bennett T. McCallum, 1987. "The case for rules in the conduct of monetary policy: a concrete example," Economic Review, Federal Reserve Bank of Richmond, issue Sep, pages 10-18.
    7. Scheide, Joachim & Sinn, Stefan, 1987. "How strong is the case for international coordination?," Kiel Working Papers 306, Kiel Institute for the World Economy (IfW).
    8. Dornbusch, Rudiger, 1988. "Doubts About the McKinnon Standard," Journal of Economic Perspectives, American Economic Association, vol. 2(1), pages 105-112, Winter.
    9. Martine Durand & Sveinbjörn Blöndal, 1988. "Are Commodity Prices Leading Indicators of OECD Prices?," OECD Economics Department Working Papers 49, OECD Publishing.
    10. Scheide, Joachim, 1987. "The ups and downs of the dollar - consequences of the changes in the monetary regime?," Kiel Working Papers 284, Kiel Institute for the World Economy (IfW).
    11. Lucas, Robert Jr., 1986. "Principles of fiscal and monetary policy," Journal of Monetary Economics, Elsevier, vol. 17(1), pages 117-134, January.
    12. Scheide, Joachim, 1988. "A k-percent rule for monetary policy in West Germany," Kiel Working Papers 337, Kiel Institute for the World Economy (IfW).
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