Money in monetary policy design: Monetary cross-checking in the New-Keynesian model

Abstract

The notion that inflation is a monetary phenomenon is a central tenet of monetary economics. It implies that inflation is ultimately a consequence of monetary policy, and the same conclusion is applied to deflation. This view is usually motivated by the quantity theory. The quantity theory states that sustained increases or decreases in the overall price level occur along with faster or slower growth rates of monetary aggregates adjusted for long-run output and velocity trends. On the basis of this theory, central banks have at times assigned an important role to monetary aggregates in the formulation of monetary policy. For example, the U.S. Federal Reserve emphasized the role of monetary aggregates when Chairman Paul Volcker set out to overcome the great inflation in the United States in 1979. Perhaps, he was partly following the earlier example of the German Bundesbank that had been more successful in fighting the inflationary impetus of the 1970s oil price shocks with the help of monetary targets. © Springer-Verlag Berlin Heidelberg 2010.