Working Paper: CEPR ID: DP6947
Authors: Guenter Beck; Volker Wieland
Abstract: 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.
Keywords: monetary policy under uncertainty; money; output gap; uncertainty; quantity theory; Taylor rules
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 |
|---|---|
| central bank misperceptions (E58) | systematic errors in monetary policy (E52) |
| systematic errors in monetary policy (E52) | inflationary trends (E31) |
| central bank misperceptions (E58) | inflationary trends (E31) |
| interest rate prescriptions (E43) | improved inflation control (E64) |
| historical output gap misperceptions (N10) | sustained trends in money growth and inflation (O42) |