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Central bank misperceptions and the role of money in interest rate rules

  • Guenter Beck

    ()

    (Johann Wolfgang Goethe University Frankfurt)

  • Volker Wieland

    ()

    (Johann Wolfgang Goethe University Frankfurt
    CEPR)

Research with Keynesian-style models has emphasized the importance of the output gap for policies aimed at controlling inflation while declaring monetary aggregates largely irrelevant. Critics, however, have argued that these models need to be modified to account for observed money growth and inflation trends, and that monetary trends may serve as a useful cross-check for monetary policy. We identify an important source of monetary trends in form of persistent central bank misperceptions regarding potential output. Simulations with historical output gap estimates indicate that such misperceptions may induce persistent errors in monetary policy and sustained trends in money growth and inflation. If interest rate prescriptions derived from Keynesian-style models are augmented with a cross-check against money-based estimates of trend inflation, inflation control is improved substantially.

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File URL: https://www.nbb.be/doc/oc/repec/reswpp/wp147en.pdf
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Paper provided by National Bank of Belgium in its series Working Paper Research with number 147.

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Length: 52 pages
Date of creation: Oct 2008
Date of revision:
Handle: RePEc:nbb:reswpp:200810-22
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