On the role of money growth targeting under inflation targeting regime

Dai, Meixing (2009): On the role of money growth targeting under inflation targeting regime.

Abstract

The mainstream inflation-targeting literature makes the strong assumption that the central bank can exactly target the interest rate which affects investment and consumption decisions and hence the money supply plays no role in the monetary policy strategy. This assumption is equivalent to admitting the perfect credibility of inflation target announced by the central bank, the perfect functioning of money and financial markets and that the central bank is willing to inject as much liquidity as the economic agents demand. Neither of these assumptions corresponds to the reality. In effect, the inflation expectations can not be easily anchored by the cheap talk of central bankers. On the other hand, the central bank may have many difficulties to target, in a context of financial instability, the interest rates which affect the real and financial decisions of private agents. We suggest that under inflation-targeting regime, money and credit markets vehicle the inflation expectations that can be anchored with a well-specified feedback money growth rule. The latter, in contrast to the Friedman’s k percent money growth rule, can help managing the inflation expectations in a manner to guarantee the dynamic stability of the economy. Furthermore, the model can be easily used to discuss the implications of the zero interest rate policy and the quantitative easing policy.

• Item Type: MPRA Paper
• Language: English
• Keywords: Interest rate rule, imperfect money and credit markets, inflation targeting, monetary targeting, inflation expectations, Friedman’s k percent money growth rule, feedback money growth rule, macroeconomic stability, zero interest rate policy, quantitative easing policy
• Subjects: E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E43 - Interest Rates: Determination, Term Structure, and Effects; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E51 - Money Supply ; Credit ; Money Multipliers; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E58 - Central Banks and Their Policies; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E44 - Financial Markets and the Macroeconomy

References

Alesina, A., O. Blanchard, J. Gali, F. Giavazzi and H. Uhlig. 2001. Defining a Macroeconomic Framework for the Euro Area. Monitoring the European Central Bank 3. London: CEPR.

Almeida, Alvaro and Charles A. E. Goodhart. 1998. “Does the Adoption of Inflation Targets Affect Central Bank Behaviour?” Banca Nazionale del Lavoro Quarterly Review (Rome), 204 (supplement), pp. 19-107.

Benhabib, Jess, Stephanie Schmitt-Grohe and Martin Uribe. 2001. “Monetary Policy and Multiple Equilibria.” American Economic Review, 91(1), pp. 167-86.

Benhabib, Jess, Stephanie Schmitt-Grohe and Martin Uribe. 2002a. “Chaotic Interest-Rate Rules.” American Economic Review, 92(2), pp. 72-78.

Benhabib, Jess, Stephanie Schmitt-Grohe and Martin Uribe. 2002b. “Avoiding Liquidity Traps.” Journal of Political Economy, 110(3), pp. 535-63.

Bernanke, Ben S. and Blinder, Alan S. 1988. “Credit, Money, and Aggregate Demand.” American Economic Review, vol. 78(2), pp. 435-39.

Bernanke, Ben S. and Frederic S. Mishkin. 1992. “Central Bank Behavior and the Strategy of Monetary Policy: Observations from Six Industrialized Countries.” in Olivier Blanchard and and Stanley Fischer, editors, NBER Macroeconomics Annual, pp. 183-238, Cambridge: MIT Press.

Bernanke, Ben S. and Ilian Mihov. 1997. “What does the Bundesbank target?” European Economic Review, Volume 41, Issue 6, pp. 1025-1053.

Bernanke, Ben S. and Frederic S. Mishkin. 1997. “Inflation Targeting: A New Framework for Monetary Policy?” Journal of Economic Perspectives 11, no. 2, pp. 97-116.

Brainard, W. 1967. “Uncertainty and the effectiveness of policy.” American Economic Review 57 (2), pp. 411–425.

Buiter W. H. and N. Panigirtzoglou. 2003. “Overcoming the Zero Bound on Nominal Interest Rates with Negative Interest on Currency: Gesell’s Solution.” Economic Journal, 113, pp. 723-746.

Cabos, Karen, Michael Funke and Nikolaus A. Siegfried. 2003. “Some Thoughts on Monetary Targeting vs. Inflation Targeting.” The German Economic Review, Vol. 5, Iss. 3, pp. 219 – 238.

Carlstrom, Charles T. and Timothy S. Fuerst. 2002. “Taylor Rules in a Model that Satisfies the Natural-Rate Hypothesis.” American Economic Review, 92(2), pp. 79-84.

Carlstrom, Charles T. and Timothy S. Fuerst. 2005. “Investment and Interest Rate Policy: A Discrete Time Analysis.” Journal of Economic Theory, 123(1), pp. 4-20.

Christiano, Lawrence and Massimo Rostagno. 2001. “Money Growth Monitoring and the Taylor Rule.” NBER Working paper No. 8539.

Christiano, Lawrence J., Roberto Motto and Massimo Rostagno. 2007. “Two Reasons Why Money and Credit May be Useful in Monetary Policy.” NBER Working Paper No. W13502.

Christiano, Lawrence, Cosmin Ilut, Roberto Motto and Massimo Rostagno. 2007. “Monetary Policy and Stock Market Boom-Bust Cycles.” manuscript.

Clarida, Richard and Mark Gertler. 1997. “How the Bundesbank Conducts Monetary Policy.” In: Romer, C. and D. Romer (eds.), Reducing Inflation: Motivation and Strategy, University of Chicago Press, Chicago, pp. 363-406.

Clarida, Richard, Jordi Gali and Mark Gertler. 1998. “Monetary policy rules in practice: Some international evidence.” European Economic Review 42, pp. 1033-1068.

Clarida, Richard, Jordi Gali and Mark Gertler. 1999. “The Science of Monetary Policy: A New Keynesian Perspective.” Journal of Economic Literature, vol. 37, pp. 1661–1707.

Dai, Meixing and Moïse Sidiropoulos. 2003. “Règle du taux d’intérêt optimale, prix des actions et taux d’inflation anticipé : une étude de la stabilité macroéconomique.” Économie Appliquée, tome LVI, n°4, p. 115-140.

Dai, Meixing and Moïse Sidiropoulos. 2005. “Should Inflation-Targeting Central Banks care about dynamic instabilities in an open economy.” Ekonomia, Vol. 8(2), pp. 1-20.

Dai, Meixing and Moïse Sidiropoulos. 2009. “Money growth rule and macro-financial stability under inflation-targeting regime.” Working paper of BETA n° 2009-5.

Dai, Meixing. 2007. “A two-pillar strategy to keep inflation expectations at bay: A basic theoretical framework.” Document de Travail du BETA n° 2007-20.

Dai, Meixing, Moïse Sidiropoulos and Eleftherios Spyromitros. 2007. “La transparence de la politique monétaire et la dynamique des marchés financiers.” Economie Appliquée, Tome LX – n° 4, pp. 141–162.

Dai, Meixing. 2006. “Inflation-targeting under a Managed Exchange Rate: the Case of Chinese Central Bank.” Journal of Chinese Economic and Business Studies, Vol. 4, No. 3, pp. 199-219.

Evans, George W. and Seppo Honkapohja. 2003) “Friedman’s money supply rule vs optimal interest rate policy.” Scottish Journal of Political Economy, vol. 50, pp. 550-566.

Feldstein, Martin and James H. Stock. 1994. “The use of a monetary aggregate to target nominal GDP.” in N.G. Mankiw, Editor, Monetary Policy, University of Chicago Press, Chicago, pp. 7–62.

Feldstein, Martin and James H. Stock. 1996. “Measuring Money Growth when Financial Markets Are Changing.” Journal of Monetary Economics, 37:1, pp. 3–27.

Freedman, C. 1996. “What operating procedures should be adopted to maintain price stability? Practical issues.” in: Federal Reserve Bank of Kansas City, Achieving Price Stability. Kansas City.

Friedman, Benjamin M. 2003. “The LM curve: a not-so-fond farewell.” NBER Working Paper n° 10123.

Friedman, Milton. 2005. “A Natural Experiment in Monetary Policy Covering Three Episodes of Growth and Decline in the Economy and the Stock Market.” Journal of Economic Perspectives, Vol. 19, issue 4, pp. 145-150.

Gersbach, Hans and Volker Hahn. 2003. “Signalling and Commitment: Monetary versus Inflation Targeting.” CEPR Discussion Papers No. 4151.

Goodfriend, Marvin. 1991. “Interest Rates and the Conduct of Monetary Policy.” Carnegie-Rochester Conference Series on Public Policy, vol. 34, pp. 7–30.

Goodhart, Charles A. E. 2007. “Whatever Became of the Monetary Aggregates?.” National Institute Economic Review 200, pp. 56-61.

Gordon, R. J. 1997. “The Time Varying Nairu and its Implications for Economic Policy.” Journal of Economic Perspective, Vol. 11, n° 2, pp. 11-32.

Groeneveld, H. , Koedijk K.G. and Kool C.J.M. 1998. “Inflation Dynamics and Monetary Strategies: Evidence from Six Industrialized Countries.” Open Economies Review, Vol. 9, No. 1, pp. 21-38.

Hafer R.W. and Garett Jones. 2008. “Dynamic IS Curves With and Without Money: An International Comparison.” Journal of International Money and Finance, vol. 27(4), pp. 609-616.

Hafer R.W., Joseph H. Haslag and Garett Jones. 2007. “On money and output: Is money redundant?” Journal of Monetary Economics, Volume 54, Issue 3, pp. 945-954.

Hess, Gregory D., David H. Small and Flint Brayton. 1993. “Nominal income targeting with the monetary base as instrument: an evaluation of McCallum’s rule.” Proceedings, Board of Governors of the Federal Reserve System (U.S.).

Issing, Otmar. 1996. “Is Monetary Targeting in Germany Still Adequate?” in Siebert, Horst (ed.), Monetary Policy in an Integrated World Economy, Institut für Weltwirtschaft an der Universität Kiel, Mohr Tübingen, pp. 117-30.

Judd, John P. and Brian Motley. 1991. “Nominal Feedback Rules for Monetary Policy.” Economic Review, Federal Reserve Bank of San Francisco, Number 3, pp. 3-17.

King, M.,. 1996. “Direct inflation targets.” in Deutsche Bundesbank (Ed.), Monetary Strategies in Europe. Vahlen, MuKnchen.

King, Robert G. and Alexander L. Wolman. 1999. “What Should the Monetary Authority Do If Prices Are Sticky?” in John B. Taylor, ed., Monetary Policy Rules. Chicago: University of Chicago Press, 1999.

King, Robert G. 2000. “The new IS-LM model: language, logic, and limits,” Economic Quarterly- Federal Reserve Bank of Richmond, issue Sum, pp. 45-103.

Laubach, Thomas. 2003. “Signalling commitment with monetary and inflation targets.” European Economic Review, Vol. 47, Iss. 6, pp. 985-1009.

Laubach, Thomas and Posen, Adam S. 1997. “Disciplined discretion: the German and Swiss monetary targeting frameworks in operation.” Federal Reserve Bank of New York, Research Paper No. 9707.

London, Simon. 2003. “Lunch with the FT: Milton Friedman.” Financial Times, June 7, 2003.

Marimon, Ramon and Sunder, Shyam. 1995. “Does a Constant Money Growth Rule Help Stabilize Inflation? Experimental Evidence.” Carnegie-Rochester Conference Series on Public Policy, vol. 43, pp. 111-56.

McCallum, Bennett T. and James G. Hoehn. 1983. “Instrument Choice for Money Stock Control with Contemporaneous and Lagged Reserve Requirements: Note.” Journal of Money, Credit and Banking, Vol. 15, No. 1, pp. 96-101.

McCallum, Bennett T. 1988a. “Robustness Properties of a Rule for Monetary Policy.” Carnegie-Rochester Conference Series on Public Policy 29, pp. 173-204.

McCallum, Bennett T. 1988b. “Targets, Indicators, and Instruments of Monetary Policy.” in Monetary Policy in an Era of Change, Washington, D. C.: American Enterprise Institute.

Minford, P., F. Perugini and N. Srinivasan. 2003. “How different are money supply rules from Taylor rules?” Indian Economic Review, Vol. 38, Iss. 2, pp. 157-166.

Mishkin, Frederic S. and Adam S. Posen. 1997. “Inflation targeting: lessons from four countries.” Economic Policy Review, Federal Reserve Bank of New York, issue Aug, pp. 9-110.

Mishkin, Frederic S. 1999. “International Experiences with Different Monetary Policy Regimes.” Journal of Monetary Economics, Vol. 43, No. 3, pp. 579-606.

Mishkin, Frederic S. 2002. “From Monetary Targeting to Inflation Targeting: Lessons from Industrialized Countries.” in Banco de Mexico, Stabilization and Monetary Policy: The International Experience (Bank of Mexico: Mexico City, 2002. pp. 99-139.

Modigliani, Franco, Robert Rasche and J Philip Cooper. 1970. “Central Bank Policy, the Money Supply, and the Short-Term Rate of Interest.” Journal of Money, Credit and Banking, Ohio State University Press, Vol. 2(2), pp. 166-218.

Romer, D. 2000. “Keynesian Macroeconomics without the LM Curve.” The Journal of Economic Perspective, Vol. 14, n° 2, pp.149-169.

Rudebusch, G. and Svensson, Lars E. O. 1999. “Policy Rules and Inflation Targeting.” in Taylor, J.B. (Ed.), Monetary Policy Rules. University of Chicago Press, Chicago, pp. 203-246.

Rudebusch, Glenn D. and Svensson, Lars E. O. 2002. “Eurosystem Monetary Targeting: Lessons from U.S. Data.” European Economic Review, Vol. 46, Iss. 3, pp. 417-42.

Söderström, Ulf. 2005. “Targeting Inflation with a Role for Money.” Economica 72 (288) , pp. 577–596.

Spiegel, Mark M. 2006. “Did Quantitative Easing by the Bank of Japan ‘Work’?” RBSF Economic Letter, Number 2006-28, pp. 1-3.

Svensson, L.E.O. 1999a. “Inflation Targeting as a Monetary Policy Rule.” Journal of Monetary Economics 43, pp. 607-654.

Svensson, L.E.O. 1999b. “Monetary Policy Issues for the Eurosystem.” Carnegie-Rochester Conferences Series on Public Policy 51(1), pp. 79-136.

Svensson, L.E.O. 2000. “The First Year of the Eurosystem: Inflation Targeting or Not?” American Economic Review: Papers and Proceedings 90, pp. 95-99.

Svensson, Lars E.O. 2002. “Inflation Targeting: Should It Be Modeled as an Instrument Rule or a Targeting Rule?” European Economic Review 46, pp. 771-780.

Svensson, Lars E.O., and Michael Woodford. 2005. “Implementing Optimal Monetary Policy through Inflation-Forecast Targeting.” in B.S. Bernanke and M. Woodford (eds.), The Inflation Targeting Debate, Chicago: University of Chicago Press.

Taylor, John B. 1985. “What Would Nominal GNP Targeting Do to the Business Cycle?.” Carnegie-Rochester Conference Series on Public Policy 22, pp, 61-84.

Taylor, John B. 1993. “Discretion versus Policy Rules in Practice.” Carnegie-Rochester Conference Series on Public Policy 39, pp. 195-214.

Walsh, Carl E. 1999. Monetary Theory and Policy, the MIT Press.

Walsh, Carl E. 2002. “Teaching Inflation Targeting: An Analysis for Intermediate Macro.” Journal of Economic Education 33 (4), pp. 333-347.

Woodford, Michael. 1998. “Doing Without Money: Controlling Inflation in a Post-Monetary World (Keynote address at the annual meeting of the Society for Economic Dynamics and Control in Mexico City, June 1996).” Review of Economic Dynamics 1, pp. 173-219.

Woodford, Michael. 2008. “How Important is Money in the Conduct of Monetary Policy?” Journal of Money, Credit and Banking, Volume 40, Number 8, pp. 1561-1598.