The Role of Money in Federal Reserve Policy

Abstract

This paper shows that money is a relevant macroeconomic indicator for the description of US monetary policy with simple rules. Empirical analysis based on novel real-time data reveals the economically and statistically significant effect of money on the federal funds rate during the Volcker–Greenspan era, highlighting an interest rate rule that better explains historical policy. The findings suggest that the bias against including money in mainstream macroeconomic models may be due to relying on an incorrect measure of money. A gradual deviation from this rule explains loose monetary policy prior to the Great Recession. Including money aggregates in rule-based policy presents a suitable framework to evaluate and guide Federal Reserve policy.

A Classical View of the Business Cycle

“…Table 3 and figure 1 show, as well, that the data prefer a more classical version of the monetary policy rule (10), in which money growth enters with a sizeable median coefficient of when estimated with the full sample of data and remains important relative to inflation and output growth across all subsamples. This result is consistent with previous findings by Ireland (2001) and Qureshi (2017) that point towards a continued role for money in estimated Taylor Rules, even in samples covering the Great Moderation. subsamples.…”

“…The fourth and fifth equations implied by ( 1) and ( 8) are entirely new and help distinguish movements in money growth triggered by monetary policy shocks from those reflecting shifts in the demand for monetary services by the non-bank public and in the 17 Ireland (2001) estimates an equation of this form within a dynamic, stochastic, New Keynesian model. Qureshi (2017) estimates the relationship using single equation methods.…”

“…Ireland (2001) estimates an equation of this form within a dynamic, stochastic New Keynesian model Qureshi (2016). estimates the relationship using single equation methods.…”

A Classical View of the Business Cycle

“…Table 3 and Figure 1 show, as well, that the data prefer a more classical version of the monetary policy rule (10), in which money growth enters with a sizeable median coefficient of when estimated with the full sample of data and remains important relative to inflation and output growth across all subsamples. This result is consistent with previous findings by Ireland (2001) and Qureshi (2017) that point toward a continued role for money in estimated Taylor Rules, even in samples covering the Great Moderation. Table 4 expands on these results by reporting the sums of the coefficients on contemporaneous and lagged values of each of the five variables entering into the policy rule (10).…”

“…Ireland (2001) estimates an equation of this form within a dynamic, stochastic, New Keynesian model. Qureshi (2017) estimates the relationship using single equation methods.…”