Money Still Makes the World Go Round: The Zonal View

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Abstract
Many leading monetary economists have come to regard the monetary aggregates as obsolete measures of the monetary policy stance. This critique has led some to view money as having lost its central role in the conduct of monetary policy. We say to those advocating excising money from monetary policy, "not so fast". To better understand the potential role for money, we develop a zonal view of monetary policy which reflects the historical regularity for the relative informativeness of the quantitative measures of monetary policy, such as the monetary aggregates, and real interest rates to depend on the inflation zone in which a central bank finds itself. The zones range from high inflation (zone 1) to deep deflation (zone 5), with intermediate zones of moderate inflation (zone 2), low inflation (zone 3) and low deflation (zone 4). We find considerable support for this view in the historical data which stretches back to the 19th century. Seen from this perspective, the past experience of central banks casts doubt on the singular importance often attributed to the short-term real interest rate as an indicator of the stance of monetary policy. This applies especially in the current low inflation environment in which many central banks find themselves. The zonal view has far-reaching implications for monetary policy frameworks, for the analytical efforts to understand the monetary policy transmission mechanism and for central bank communication strategies. This paper was prepared for the 21st Congress of the European Economic Association held in Vienna on August 27, 2006. The views expressed in the paper are solely those of the authors.

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