Working Paper: CEPR ID: DP6097
Authors: Günter Beck; Volker Wieland
Abstract: The European Central Bank has assigned a special role to money in its two pillar strategy and has received much criticism for this decision. The case against including money in the central bank's interest rate rule is based on a standard model of the monetary transmission process that underlies many contributions to research on monetary policy in the last two decades. In this paper, we develop a justification for including money in the interest rate rule by allowing for imperfect knowledge regarding unobservables such as potential output and equilibrium interest rates. We formulate a novel characterization of ECB-style monetary cross-checking and show that it can generate substantial stabilization benefits in the event of persistent policy misperceptions regarding potential output.
Keywords: European Central Bank; Monetary Policy; Monetary Policy Under Uncertainty; Money; Quantity Theory
JEL Codes: E32; E41; E43; E52; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| including money in the interest rate rule (E49) | significant stabilization benefits (E63) |
| persistent misperceptions about potential output (E66) | significant stabilization benefits (E63) |
| money growth (O42) | inflation (E31) |
| two-component interest rate rule (E43) | adjustments based on filtered money growth (E49) |
| deviations of inflation from targets (E31) | adjustments in interest rates (E43) |
| crosschecking process (Y10) | learning about appropriate level of interest rates (E43) |
| correcting policy biases (J78) | stabilization of inflation and money growth (E63) |