Luca Benati, Robert Lucas, Juan Pablo Nicolini, and Warren E. Weber:
Long-run money demand redux: Most economists and central bankers no longer consider money supply measures to be useful for conducting monetary policy. One reason is the alleged instability of the relationship between monetary aggregates. This column uses data from 32 countries and spanning up to 100 years to argue that the long-run demand for money is alive and well. Results show a remarkable stability in long run money demand, both within and across countries. Nonetheless, short-run departures can be large and persistent, and further research is needed.
Over the last three decades, most economists and central bankers have come to doubt the usefulness of money supply measures for conducting monetary policy, and have turned to macroeconomic models in which monetary aggregates have no role.
What was the main reason behind this move away from monetary aggregates? In our view, it was the alleged disappearance, starting from the early 1980s, of any previously identified stable relationship between monetary aggregates, GDP, and interest rates. For the US, for example, researchers such as Friedman and Kuttner (1992) have documented the breakdown during those years of any stable long-run demand for several alternative monetary aggregates. By the same token, in the Eurozone, the ECB’s so-called monetary pillar (a reference value for the annual growth rate of M3 derived from a money demand equation) has come to be seen as too unreliable to be of any use at all.
There is a clear sense in which this move away from monetary aggregates has left monetary policy untroubled. Over the same decades, there was a surge in the number of central banks that were explicitly or implicitly following inflation-targeting policies in which the monetary policy instrument was the short-term interest rate. And the result has clearly been remarkable – inflation has been defeated. This has been the case for developed economies that saw their inflation rates climb to two digits for a few years in the late 1970s and early 1980s, for emerging economies that experienced hyperinflation during the same years, and for everything in between. In 2015, with a yearly inflation rate of around 30%, Argentina had one of the highest inflation rates in the world – a rate that, ironically, would have been one of the lowest in Latin America in the 1980s.
In this column, we first review recent work on the long-run demand for money, and argue that it is alive and well. We then explain why we believe that this finding may contribute to the monetary policy debate. ...