The Role of Money in Monetary Policy at the Lower Bound

44 Pages Posted: 16 Jun 2020

See all articles by Roberto M. Billi

Roberto M. Billi

Sveriges Riksbank

Ulf Söderström

Sveriges Riksbank

Carl E. Walsh

U. of California, Santa Cruz

Date Written: June 2020

Abstract

In light of the current low-interest-rate environment, we reconsider the merit of a money growth target (MGT) relative to a conventional inflation targeting (IT) regime, and to the notion of price level targeting (PLT). Through the lens of a New Keynesian model, and accounting for a zero lower bound (ZLB) constraint on the nominal interest rate, we show, not surprisingly, that PLT performs best in terms of social welfare. However, the ranking between IT and MGT is not a foregone conclusion. In particular, although MGT makes monetary policy vulnerable to money demand shocks, it contributes to achieving price level stability and reduces the incidence and severity of the ZLB relative to both IT and PLT. We also show that MGT lessens the need for the fiscal authority to engage alongside the central bank in fighting recessions. To illustrate this fiscal benefit of MGT, we introduce a simple rule for the fiscal authority to raise government purchases when GDP falls below potential. If the government fails to make up for a substantial share of the shortfalls in GDP, then IT performs worse than MGT from the perspective of society.

Keywords: Automatic Stabilizers, Fiscal policy, Friedman's k-percent rule, ZLB constraint

JEL Classification: E31, E42, E52

Suggested Citation

Billi, Roberto M. and Söderström, Ulf and Walsh, Carl E., The Role of Money in Monetary Policy at the Lower Bound (June 2020). CEPR Discussion Paper No. DP14865, Available at SSRN: https://ssrn.com/abstract=3628186

Roberto M. Billi (Contact Author)

Sveriges Riksbank ( email )

Brunkebergstorg 11
SE-103 37 Stockholm
Sweden

HOME PAGE: http://www.rmbilli.com

Ulf Söderström

Sveriges Riksbank

Brunkebergstorg 11
SE-103 37 Stockholm
Sweden

Carl E. Walsh

U. of California, Santa Cruz ( email )

1156 High St
Santa Cruz, CA 95064
United States

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