Two Reasons Why Money and Credit May be Useful in Monetary Policy
We describe two examples which illustrate in different ways how money and credit may be useful in the conduct of monetary policy. Our first example shows how monitoring money and credit can help anchor private sector expectations about inflation. Our second example shows that a monetary policy that focuses too narrowly on inflation may inadvertently contribute to welfare-reducing boom-bust cycles in real and financial variables. The example is of some interest because it is based on a monetary policy rule fit to aggregate data. We show that a policy of monetary tightening when credit growth is strong can mitigate the problems identified in our second example.
Paper presented at the Fourth ECB Central Banking Conference, The Role of Money: Money and Monetary Policy in the Twenty-First Century," Frankfurt, November 9-10, 2006. We would like to thank Claudio Borio, Dale Henderson, John Leahy, Andy Levin, Christian Noyer, Lars Svensson and Harald Uhlig for helpful discussions. The views expressed in this paper do not necessarily reflect the views of the European Central Bank.