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Thursday, November 09, 2006

Should Money Help to Guide Monetary Policy?

Jean-Claude Trichet, president of the European Central Bank, argues that money should play a role in monetary policy:

Money’s vital role in monetary policy, by Jean-Claude Trichet, Commentary, Financial Times: ...Over the next two days, the European Central Bank will host a conference to discuss the role of money in monetary policymaking. At present, the dominant academic view seems to be that monetary aggregates should have no part in monetary policy decisions. ... I do not share this view. ...

Do not mistake me for a monetary Luddite: I have immense appreciation for the intellectual elegance and sophistication of modern monetary policy models that leave no room for money. In many respects, I fully agree with their implications regarding the benefits of price stability, the crucial importance of central bank credibility, the advantages of pursuing a clear and predictable policy and the centrality of private inflation expectations. ... These ... considerations have ... strongly influenced the design of the ECB’s policy framework. Yet, I cannot dispel my doubts that a model of monetary policy that includes no role for money is incomplete in some important respects.

Academic research is starting to address some of these shortcomings. By introducing financial markets, informational asymmetries and transaction costs into the benchmark model, money and credit developments are given a role in determining macroeconomic outcomes. Moreover, empirical literature has emerged suggesting that monetary developments may be associated with asset price dynamics.

More fundamentally, the European experience – both before and after the introduction of the euro – suggests that assigning an important role to money in monetary policy deliberations and communication has, in practice, helped to serve precisely those principles that modern monetary policy literature holds dear. To take just two examples: I am convinced that an important role for money helps to give the policy discussion an appropriate medium- to longer-term orientation. ... Equally, in our own recent experience, when the economic analysis is complex and its conclusions uncertain, cross-checks with the monetary analysis have proved extremely useful. ...

Monetary policy ... research may offer some lessons for a better understanding of our own decision-making process. In monetary policy, the fact that the pooling of experience and diversity of points of view are deemed essential for reaching the right decision is illustrated by the use of collegial decision-making in all main central banks. Similarly, a pillar based on monetary analysis calls for central banks to consider the outcome of their decisions within a longer-term context; to take due account of past experience and insights accumulated over time; and not to follow too slavishly the latest analytical techniques. Monetary analysis was central to the strategies of the most successful European central banks before the euro ... This legacy cannot be disregarded lightly. Rather, we should strive to use the new and more sophisticated techniques that are being developed to enhance and complement the principles underlying our past successes. ...

This topic has been covered here many times. As I've noted before, my mind is open on this, but even measuring monetary aggregates accurately is problematic so I would not assign them much weight in the decision making process:

    Posted by on Thursday, November 9, 2006 at 02:10 AM in Economics, Monetary Policy | Permalink  TrackBack (1)  Comments (6)


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