Why Money Growth Determines Inflation in the Long Run: Answering the Woodford Critique

Abstract

Woodford argues that it is not appropriate to regard inflation in the steady state of New Keynesian models as determined by steady-state money growth. Woodford instead argues that the intercept term in the monetary authority's interest rate policy rule determines steady-state inflation. In this paper, I offer an alternative interpretation of steady-state behavior, according to which it is appropriate to regard steady-state inflation as determined by steady-state money growth. The argument relies on traditional interpretations of the central bank's power in the long run and appeals to model properties that are common to textbook and New Keynesian analysis. According to this argument, the only way the central bank can control interest rates in the long run is via affecting inflation, and its only means available for determining inflation is by determining the money growth rate. Copyright (c) 2008 The Ohio State University.

The demand for Divisia Money: Theory and evidence

“…Interest rate rules of the general form proposed by Taylor then were incorporated into the New Keynesian models developed by Clarida, Galí, and Gertler (1999) and Woodford (2003). And though Nelson (2008) and even Taylor (1996) himself showed that New Keynesian models with interest rate rules are not inconsistent with the quantity-theoretic view that inflation gets determined, in the long run, by the growth rate of the money supply, these models also served to illustrate how monetary policy analysis could be conducted within a theoretically coherent and internally consistent framework that makes no explicit reference to either the demand for or supply of money. As such, models of this type also excluded any independent transmission mechanism by which variations in the quantity of money can affect real activity independent of any influence associated with variations in interest rates.…”

The behavior of money and other economic variables: Two natural experiments

“…As Nelson (2008) points out, such models became highly problematic as descriptions of long-run inflation. The Taylor-type equations describing central-bank monetary policy in these New Keynesian models reduce to a steady-state Fisher equation and the Phillips-curve equations governing inflation dynamics to an equilibrium condition between actual and anticipated rates of inflation.…”

Is Inflation a Monetary Phenomenon in the East European Economies? – Multifrequency Bayesian Quantile Inference

“…This theory proposes that relationship between money supply growth and inflation is unity in the long-run, whereby this nexus is based on purely monetary forces. According to Budina et al (2006), high inflation cannot persist unless it is caused by an excessive money creation, while Nelson (2008) asserted that money provides useful information for monetary policy. On the other hand, Duczynski (2005), Telatar and Cavusoglu (2005) and Horvath, Komarek and Rozsypal (2011) claimed that the role of money in monetary policy conduct has been greatly disputed in recent years, thus a further evidence is needed.…”