Monetary policy, monetarism, Taylor’s rule

Francisco Rosende

English

Research Papers in Economics

MONEY  AND  INFLATION:  THE  END  OF  MONETARISM? *
For over a decade, in a considerable number of economies the monetary
policy debate has focused on defining criteria to set the interest rate, at which the
Central Bank supplies short-term funds to the banking system (the so-called
monetary policy rate or TPM). Thus, for the past ten years several adjustment
strategies have been proposed for that interest rate as a function of the behavior
of certain target variables of monetary policy, such as inflation, output, or the
balance of payments of the current account. Each of these variables is included in
the “interest rate rule” with a certain weight, and is measured in terms of the
difference between its actual level and the target proposed by the relevant
authorities.
This view of monetary policy is inspired by what has been central banking
practice in industrialized economies for almost twenty years, and by the influential
contribution of John B.Taylor in 1993,1 where he proposed a conceptual framework
for the assessment and administration of this policy.
Perhaps one of the most outstanding aspects covered in monetary policy
discussions, and which has been set forth in several economies in the past decade,
is the absence of a systematic analysis of money supply movements at the moment
of defining the adjustment criteria for the TPM. Considerations about the possible
instability of money demand, and monetary aggregates’ endogeneity to the
evolution of other macroeconomic variables, are among the explanations that
have been given to justify this extensive omission of money in the discussion and
analysis of monetary policy.
Some economists claim that the basic principles of monetary theory continue
to be totally valid, but, in economies that have succeeded in reducing the inflation
rate to very low levels, the link between inflation and money supply movements
would appear to weaken substantially.2 It is as if the very fact of attaining a
considerable reduction in inflation created a scenario where belief in the authorities’
commitment with price stability lead the public to disregard the capacity of short-
term money supply movements to predict future inflation.
The above subjects are examined in this panel. On the one hand, the works
by Herrou-Aragón and Rosende discuss, conceptually, two central issues in the
Cuadernos de Economía, Año 40, Nº 121, pp. 679-680 (diciembre 2003)
Keywords: Monetary Policy, Monetarism; Taylor’s Rule
JEL Classification: E50; E52; E58
* This introduction was written by Francisco Rosende R., Department of Economics,
Catholic University of Chile, Email: frosende@faceapuc.cl
1 John B. Taylor (1993), “Discretion Versus Policy Rules in Practice,” Carnagie-Rochester
Conference Series on Public Policy,Vol. 39, pp.195-214.
2 For example, see W.A. Razzak (2001), “Money in the Era of Inflation Targeting”,
Discussion Paper Series, Reserve Bank of New Zealand, July.
Introduc. F.Rosende.pm6 2/12/03, 10:50 679680 CUADERNOS DE ECONOMIA (Vol. 40, Nº 121, diciembre 2003)
monetary theory agenda, namely: (i) the foundations –and limitations– of an
approach that relies on the design and application of some kind of rule for TPM
movements of the “Taylor rule” type, and (ii) the validity of the statement that
contends that the monetarist approach has been displaced by other approaches
that may disregard money supply movements for the purposes of explaining
inflation.
The works by García and Valdés, Vergara, and De Gregorio examine the link
between money and inflation from an empirical standpoint.  In particular, the two
first ones (i.e. García and Valdés, and Vergara’s) focus their analyses on the
experience of the Chilean economy in the past few years.
Possibly the most important conclusions that emerge from these works are:
(i) that further empirical analysis is needed in order to establish the short-term
effects of monetary policy, and that emphasis should be put on transmission
channels and on the characteristics of the money demand function; and (ii) that
similarly to some decades ago, when a strong debate was opened around the
effects of money supply in the economy, today the design of an analytical
framework to study the interaction of monetary and real variables in the short run
is at the top of the list of the macroeconomic research agenda.
Introduc. F.Rosende.pm6 2/12/03, 10:50 680

Money and Inflation: The End of Monetarism - Introduction

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Money and Inflation: The End of Monetarism - Introduction

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