The Monetary Instrument Matters

FRB of St. Louis Working Paper No. 2004-026B

37 Pages Posted: 29 Jul 2005

See all articles by William T. Gavin

William T. Gavin

Federal Reserve Bank of St. Louis - Research Division; University of Memphis Department of Economics

Benjamin D. Keen

University of Oklahoma - Department of Economics

Michael R. Pakko

Arkansas Economic Development Institute

Date Written: March 2005

Abstract

This paper revisits the issue of money growth versus the interest rate as the instrument of monetary policy. Using a dynamic stochastic general equilibrium framework, we examine the effects of alternative monetary policy rules on inflation persistence, the information content of monetary data, and real variables. We show that inflation persistence and the variability of inflation relative to money growth depends on whether the central bank follows a money growth rule or an interest rate rule. With a money growth rule, inflation is not persistent and the price level is much more volatile than the money supply. Those counterfactual implications are eliminated by the use of interest rate rules whether prices are sticky or not. A central bank's utilization of interest rate rules, however, obscures the information content of monetary aggregates and also leads to subtle problems for econometricians trying to estimate money demand functions or to identify shocks to the trend and cycle components of the money stock.

Keywords: Monetary policy rules, sticky prices, flexible prices

JEL Classification: E31, E32, E42

Suggested Citation

Gavin, William T. and Keen, Benjamin D. and Pakko, Michael R., The Monetary Instrument Matters (March 2005). FRB of St. Louis Working Paper No. 2004-026B, Available at SSRN: https://ssrn.com/abstract=761965 or http://dx.doi.org/10.2139/ssrn.761965

William T. Gavin (Contact Author)

Federal Reserve Bank of St. Louis - Research Division ( email )

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HOME PAGE: http://www.gavinecon.com

University of Memphis Department of Economics ( email )

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Benjamin D. Keen

University of Oklahoma - Department of Economics ( email )

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Michael R. Pakko

Arkansas Economic Development Institute ( email )

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Little Rock, AR 72204
United States
501-569-8541 (Phone)
501-569-8538 (Fax)

HOME PAGE: http://https://ualr.edu/aedi/

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