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A NOTE ON MONEY AND THE CONDUCT OF MONETARY POLICY

Published online by Cambridge University Press:  30 July 2013

Jagjit S. Chadha ,
Luisa Corrado  and
Sean Holly
Jagjit S. Chadha
Affiliation:
University of Kent
Luisa Corrado*
Affiliation:
University of Rome, Tor Vergata and University of Cambridge
Sean Holly
Affiliation:
University of Cambridge
*
Address correspondence to: Luisa Corrado, Department of Economics, Law and Institutions, University of Rome Tor Vergata, Rome, Italy; e-mail: [email protected].
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Abstract

Prior to the financial crisis, mainstream monetary policy practice had become disconnected from money. We outline the basic rationale for this development using a simple model of money and credit in which we explore the conditions under which money matters directly for the conduct of policy. Then, using a DSGE model, we examine the circumstances under which money becomes more closely linked to inflation. We find that money matters when the variance of the supply of lending dominates productivity and the velocity of money demand. This is because amplifying the role of loans supply leads to an expansion in aggregate demand, via a compression of the external finance premium, which is inflationary. We consider a number of alternative monetary policy rules, and find that a rule which exploits the joint information from money and the external finance premium performs best.

Keywords

MoneyDynamic Stochastic General EquilibriumPolicy RulesExternal Finance Premium
Type
Note
Information
Macroeconomic Dynamics , Volume 18 , Issue 8 , December 2014 , pp. 1854 - 1883
Copyright
Copyright © Cambridge University Press 2013 

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