- Email: [email protected]
Introduction to conference volume on money and monetary policy
Journal of International Money and Finance 28 (2009) 1083–1085
Contents lists available at ScienceDirect
Journal of International Money and Finance journal homepage: www.elsevier.com/locate/jimf
Guest editorial
Introduction to conference volume on money and monetary policyq
Not entirely facetiously, I was tempted to suggest this conference be named ‘‘Money and Monetary Policy: Are They Related?’’ Despite the close etymological relationship between the words ‘‘money’’ and ‘‘monetary policy’’, an observer of U.S. monetary policy would conclude that the quantity of money has no role in monetary policy in practice. An observer of much research in monetary economics might conclude this is as it should be. In the United States, the quantity of money hardly appears in monetary policy discussions, other than as an endogenous variable mainly reflecting transitory factors which should have no effect on the central bank’s actions. At the European Central Bank, money has more of a role as an indicator than at the Federal Reserve, although the value of any such role has been controversial. James Lothian and I organized this conference to bring together researchers who are examining the importance of money for inflation and monetary policy. Besides our own personal edification, a purpose of this conference is to renew interest in these issues and make available some new research on money and inflation. In addition, the relationship between inflation and money growth has become of substantial practical importance in the aftermath of the Financial Crisis of 2008 and its attendant dramatic increase in the monetary base in the United States. Given Milton Friedman’s importance in the resurgence of the quantity theory in the last half of the Twentieth Century and his passing, it is appropriate to begin with a discussion of his intellectual contributions and we do so. The articles in this volume on Friedman’s contributions are selective, not exhaustive. Much has been published elsewhere and no doubt more will be published. For example, elsewhere, I have discussed a personal aspect of Friedman’s contribution, his influence as a teacher (Dwyer, 1999). In this volume, James R. Lothian summarizes Friedman’s contributions to monetary economics, including the special atmosphere of the Money and Banking Workshop at the University of Chicago. As Lothian shows, Friedman’s contributions to monetary economics were many. Even so, Lothian discusses in detail two fundamental ones: the close relationship between substantial money growth and inflation; and the uninformativeness of the Phillips’ curve as a long-run theory of unemployment, let alone a theory of inflation. Russell Boyer then summarizes Milton Friedman’s intellectual contributions in a field where his contributions are less noted, international monetary economics. Here, Friedman was a precursor to later developments including the monetary theory of the balance of payments and optimal currency q
The views expressed here are the author’s and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any errors are the author’s responsibility. 0261-5606/$ – see front matter Ó 2009 Elsevier Ltd. All rights reserved. doi:10.1016/j.jimonfin.2009.06.004
1084
Guest editorial / Journal of International Money and Finance 28 (2009) 1083–1085
areas. Boyer shows that Friedman’s paper, really memorandum, The Case for Flexible Exchange Rates (1953), presaged much of the later development of monetary economics in following decades. As Boyer shows, Friedman outlined a theoretical model that he used to compare existing exchange-rate arrangements with the untested flexible-exchange-rate regime. Friedman predicted that pegged exchange rates with periodic adjustments would be subject to repeated crises and large adjustments because of the incentives created for speculators to bet against the central bank. This prediction was borne out by subsequent developments. This is similar to Friedman’s later use of theory in his Presidential Address to predict that governments cannot permanently lower unemployment rates, and that attempting to do so is more likely to result in higher inflation than anything else. Pursuing one aspect of Boyer’s broad review, George Tavlas explores the literature on optimal currency areas, its successes and its failures. In recent years, this has been of substantial practical importance given the creation of the euro area. Which countries are likely to benefit from being part of the euro area? Which countries not? As Tavlas concludes, the literature seems to be moving toward better answers than in the past. The rise of the euro area has engendered many questions, one particularly relevant for this conference being the role of money in monetary policy. The ECB has emphasized that monetary analysis is part of the assessment of appropriate monetary policy. The emphasis appears to have been on the longer-term trend of inflation and the relationship of that trend to money growth. A particularly difficult problem for the ECB has been discerning growth of the nominal quantity of money suggestive of higher future inflation and growth associated with changes in the demand for money unrelated to inflation developments. Bjo¨rn Fischer, Michele Lenza, Huw Pill and Lucrezia Reichlin examine evidence on the actual role money has played at the ECB. Fischer et al. summarize the Quarterly Monetary Assessment for forecasting inflation and the Broad Macroeconomic Projections Exercise. The Quarterly Monetary Assessment is a detailed analysis of monetary developments in the euro area.1 The Broad Macroeconomic Exercise uses standard macroeconomic models and judgment to produce forecasts along conventional lines. Using detailed data and information on deliberations and carefully using real-time data to examine decisions, they come to a quite convincing conclusion that monetary analysis has played an important role. Analysis based on macroeconomic models and data on real developments generally have prevailed though when the signals from monetary analysis and macroeconomic analysis are mixed. Boris Hofmann examines the informativeness of money for inflation in the euro area in detail. He uses both computed M3–M3 being the ECB’s preferred measure – and the series with judgmental adjustments. He finds that adjusted M3 is more informative than the unadjusted series. He also finds that combination forecasts based on both monetary and macroeconomic indicators provide some improvement in forecasts, although not substantially so. Hofmann’s evidence is similar to many others’ in its finding that simple time-series models can do a creditable job of forecasting inflation within European and North American economies. While partly or largely explicable for reasons explained by Kishor and Kochin (2007), even so, this sort of evidence never has been the primary evidence on the importance of money. Rather, going back to the 1950s, episodes of substantial inflation in various times and places have been the primary support. This was so in the publication of Studies in the Quantity Theory of Money (1956) and continued in later papers and books. Emiliano Basco, Laura D’Amato and Lorena Garegnani continue this tradition using informative data from Argentina. Monetary policy in Argentina has generated dramatic changes in money growth in a relative brief period. This is both unfortunate for Argentinians and informative for a statistical analysis. As a result, it is possible to compare money growth and inflation across large changes in monetary conditions in a 30-year period in a single country. They distinguish a high-inflation period from 1977 to 1998 with 9.7 percent inflation; a hyperinflation period from 1989 to 1991 with 25.9 percent inflation; and a low-inflation period since with average inflation of 0.4 percent per year. They find that the changes in inflation are associated with similar changes in money growth. They also find that inflation expectations become more important for changes in the inflation rate in the
1
As might be expected for a new currency, this has been challenging.
Guest editorial / Journal of International Money and Finance 28 (2009) 1083–1085
1085
high-inflation regime, a conclusion that can more credibly be made for one country in a short period than across countries. Consistent with other analyses, they find that the statistical relationship between money growth and inflation is weaker in the low-inflation regime. This suggests that the lower correlations commonly found for countries with low inflation are not due to differences in the countries that have low inflation rates but rather to differences in the inflation rate. James R. Lothian and Cornelia McCarthy examine changes in monetary conditions over much smaller changes in inflation in OECD countries after World War II. They identify three different periods: the Bretton Woods period from 1960 to 1970 with inflation of 3.8 percent; a higher inflation period with from 1971 to 1982 with inflation of 9.7 percent; and a return to low inflation from 1983 to 1998 with inflation of 3.9 percent. Even with a high inflation rate of only ten percent and a low rate of four percent, Lothian and McCarthy find a clear association between money growth and inflation, especially when money growth is measured net of real income growth. While not a particularly important adjustment when comparing countries with inflation of ten and one hundred percent, differences in real income growth can be large relative to differences in inflation rates when inflation is low. They find that the use of excess money growth, nominal money growth less real income growth, is an important improvement over nominal money growth alone. Lothian and McCarthy also extend the typical analyses of money and inflation by considering the implications for exchange rates. Along the lines of closed-economy analyses, the nominal exchange is expected to adjust proportionately with money stock growth and the real exchange is expected to be unaffected by growth of the money stock. Their evidence largely is in accord with these predictions. Mark Fisher and I first document propositions suggested by the empirical papers in this volume and in the literature, namely that the link between excess money growth and inflation is closer when inflation is higher and is closer over longer periods of time. Then we provide an explanation based on variation of the demand for money and the supply of money. Informally, transitory variation in innovations in the demand for money and lower frequency variations in innovations in the supply of money can produce these results.2 We show this more formally. We then examine the non-obvious implication that higher serial correlation of the inflation rate is associated with greater increases in the correlation of inflation and excess money growth and find that it is consistent with the data. I think this volume continues in the tradition of Milton Friedman’s research. The papers in this volume are based on suppositions that theoretical developments and empirical evidence will continue to improve our understanding of monetary conditions and of inflation. Based on the evidence to date, I think that money growth is an important determinant of inflation over longer periods of time.3 The papers in this volume elaborate on that evidence, improving our knowledge of how inflation and money growth are linked. Overall, I also think this volume goes some way to bolstering the argument that monetary developments can be informative for monetary policy, as they are at the ECB, and that it is a mistake to ignore money growth. References Dwyer Jr., G.P., 1999. How was Milton Friedman distinctive as a teacher? In: Hammond, D. (Ed.), In The Intellectual Legacy of Milton Friedman, vol. 1 Edward Elgar Publishing Limited, Cheltenham, United Kingdom, pp. 3–8. Friedman, M. (Ed.), 1956. Studies in the Quantity Theory of Money. University of Chicago Press, Chicago. Friedman, M., 1953. The case for flexible exchange rates. In: Essays in Positive Economics. University of Chicago Press, Chicago, pp. 157–203. Kishor, N.K., Kochin, L.A., 2007. The success of the fed and the death of monetarism. Economic Inquiry 45 (1), 56–70.
Gerald P. Dwyer Research Department, Federal Reserve Bank of Atlanta, 1000 Peachtree St., N.E. Atlanta, GA 30039, USA Universidad Carlos III de Madrid Departamento de Economı´a de la Empresa, Calle Madrid, 126, 28903 Getafe, Madrid, Spain E-mail address: [email protected]
2 3
‘‘Lower frequency variation’’ is roughly the same as ‘‘longer run variation’’. I imagine that most or all of the authors in this volume would agree, but I would not pretend to speak for them.
Contents lists available at ScienceDirect
Journal of International Money and Finance journal homepage: www.elsevier.com/locate/jimf
Guest editorial
Introduction to conference volume on money and monetary policyq
Not entirely facetiously, I was tempted to suggest this conference be named ‘‘Money and Monetary Policy: Are They Related?’’ Despite the close etymological relationship between the words ‘‘money’’ and ‘‘monetary policy’’, an observer of U.S. monetary policy would conclude that the quantity of money has no role in monetary policy in practice. An observer of much research in monetary economics might conclude this is as it should be. In the United States, the quantity of money hardly appears in monetary policy discussions, other than as an endogenous variable mainly reflecting transitory factors which should have no effect on the central bank’s actions. At the European Central Bank, money has more of a role as an indicator than at the Federal Reserve, although the value of any such role has been controversial. James Lothian and I organized this conference to bring together researchers who are examining the importance of money for inflation and monetary policy. Besides our own personal edification, a purpose of this conference is to renew interest in these issues and make available some new research on money and inflation. In addition, the relationship between inflation and money growth has become of substantial practical importance in the aftermath of the Financial Crisis of 2008 and its attendant dramatic increase in the monetary base in the United States. Given Milton Friedman’s importance in the resurgence of the quantity theory in the last half of the Twentieth Century and his passing, it is appropriate to begin with a discussion of his intellectual contributions and we do so. The articles in this volume on Friedman’s contributions are selective, not exhaustive. Much has been published elsewhere and no doubt more will be published. For example, elsewhere, I have discussed a personal aspect of Friedman’s contribution, his influence as a teacher (Dwyer, 1999). In this volume, James R. Lothian summarizes Friedman’s contributions to monetary economics, including the special atmosphere of the Money and Banking Workshop at the University of Chicago. As Lothian shows, Friedman’s contributions to monetary economics were many. Even so, Lothian discusses in detail two fundamental ones: the close relationship between substantial money growth and inflation; and the uninformativeness of the Phillips’ curve as a long-run theory of unemployment, let alone a theory of inflation. Russell Boyer then summarizes Milton Friedman’s intellectual contributions in a field where his contributions are less noted, international monetary economics. Here, Friedman was a precursor to later developments including the monetary theory of the balance of payments and optimal currency q
The views expressed here are the author’s and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any errors are the author’s responsibility. 0261-5606/$ – see front matter Ó 2009 Elsevier Ltd. All rights reserved. doi:10.1016/j.jimonfin.2009.06.004
1084
Guest editorial / Journal of International Money and Finance 28 (2009) 1083–1085
areas. Boyer shows that Friedman’s paper, really memorandum, The Case for Flexible Exchange Rates (1953), presaged much of the later development of monetary economics in following decades. As Boyer shows, Friedman outlined a theoretical model that he used to compare existing exchange-rate arrangements with the untested flexible-exchange-rate regime. Friedman predicted that pegged exchange rates with periodic adjustments would be subject to repeated crises and large adjustments because of the incentives created for speculators to bet against the central bank. This prediction was borne out by subsequent developments. This is similar to Friedman’s later use of theory in his Presidential Address to predict that governments cannot permanently lower unemployment rates, and that attempting to do so is more likely to result in higher inflation than anything else. Pursuing one aspect of Boyer’s broad review, George Tavlas explores the literature on optimal currency areas, its successes and its failures. In recent years, this has been of substantial practical importance given the creation of the euro area. Which countries are likely to benefit from being part of the euro area? Which countries not? As Tavlas concludes, the literature seems to be moving toward better answers than in the past. The rise of the euro area has engendered many questions, one particularly relevant for this conference being the role of money in monetary policy. The ECB has emphasized that monetary analysis is part of the assessment of appropriate monetary policy. The emphasis appears to have been on the longer-term trend of inflation and the relationship of that trend to money growth. A particularly difficult problem for the ECB has been discerning growth of the nominal quantity of money suggestive of higher future inflation and growth associated with changes in the demand for money unrelated to inflation developments. Bjo¨rn Fischer, Michele Lenza, Huw Pill and Lucrezia Reichlin examine evidence on the actual role money has played at the ECB. Fischer et al. summarize the Quarterly Monetary Assessment for forecasting inflation and the Broad Macroeconomic Projections Exercise. The Quarterly Monetary Assessment is a detailed analysis of monetary developments in the euro area.1 The Broad Macroeconomic Exercise uses standard macroeconomic models and judgment to produce forecasts along conventional lines. Using detailed data and information on deliberations and carefully using real-time data to examine decisions, they come to a quite convincing conclusion that monetary analysis has played an important role. Analysis based on macroeconomic models and data on real developments generally have prevailed though when the signals from monetary analysis and macroeconomic analysis are mixed. Boris Hofmann examines the informativeness of money for inflation in the euro area in detail. He uses both computed M3–M3 being the ECB’s preferred measure – and the series with judgmental adjustments. He finds that adjusted M3 is more informative than the unadjusted series. He also finds that combination forecasts based on both monetary and macroeconomic indicators provide some improvement in forecasts, although not substantially so. Hofmann’s evidence is similar to many others’ in its finding that simple time-series models can do a creditable job of forecasting inflation within European and North American economies. While partly or largely explicable for reasons explained by Kishor and Kochin (2007), even so, this sort of evidence never has been the primary evidence on the importance of money. Rather, going back to the 1950s, episodes of substantial inflation in various times and places have been the primary support. This was so in the publication of Studies in the Quantity Theory of Money (1956) and continued in later papers and books. Emiliano Basco, Laura D’Amato and Lorena Garegnani continue this tradition using informative data from Argentina. Monetary policy in Argentina has generated dramatic changes in money growth in a relative brief period. This is both unfortunate for Argentinians and informative for a statistical analysis. As a result, it is possible to compare money growth and inflation across large changes in monetary conditions in a 30-year period in a single country. They distinguish a high-inflation period from 1977 to 1998 with 9.7 percent inflation; a hyperinflation period from 1989 to 1991 with 25.9 percent inflation; and a low-inflation period since with average inflation of 0.4 percent per year. They find that the changes in inflation are associated with similar changes in money growth. They also find that inflation expectations become more important for changes in the inflation rate in the
1
As might be expected for a new currency, this has been challenging.
Guest editorial / Journal of International Money and Finance 28 (2009) 1083–1085
1085
high-inflation regime, a conclusion that can more credibly be made for one country in a short period than across countries. Consistent with other analyses, they find that the statistical relationship between money growth and inflation is weaker in the low-inflation regime. This suggests that the lower correlations commonly found for countries with low inflation are not due to differences in the countries that have low inflation rates but rather to differences in the inflation rate. James R. Lothian and Cornelia McCarthy examine changes in monetary conditions over much smaller changes in inflation in OECD countries after World War II. They identify three different periods: the Bretton Woods period from 1960 to 1970 with inflation of 3.8 percent; a higher inflation period with from 1971 to 1982 with inflation of 9.7 percent; and a return to low inflation from 1983 to 1998 with inflation of 3.9 percent. Even with a high inflation rate of only ten percent and a low rate of four percent, Lothian and McCarthy find a clear association between money growth and inflation, especially when money growth is measured net of real income growth. While not a particularly important adjustment when comparing countries with inflation of ten and one hundred percent, differences in real income growth can be large relative to differences in inflation rates when inflation is low. They find that the use of excess money growth, nominal money growth less real income growth, is an important improvement over nominal money growth alone. Lothian and McCarthy also extend the typical analyses of money and inflation by considering the implications for exchange rates. Along the lines of closed-economy analyses, the nominal exchange is expected to adjust proportionately with money stock growth and the real exchange is expected to be unaffected by growth of the money stock. Their evidence largely is in accord with these predictions. Mark Fisher and I first document propositions suggested by the empirical papers in this volume and in the literature, namely that the link between excess money growth and inflation is closer when inflation is higher and is closer over longer periods of time. Then we provide an explanation based on variation of the demand for money and the supply of money. Informally, transitory variation in innovations in the demand for money and lower frequency variations in innovations in the supply of money can produce these results.2 We show this more formally. We then examine the non-obvious implication that higher serial correlation of the inflation rate is associated with greater increases in the correlation of inflation and excess money growth and find that it is consistent with the data. I think this volume continues in the tradition of Milton Friedman’s research. The papers in this volume are based on suppositions that theoretical developments and empirical evidence will continue to improve our understanding of monetary conditions and of inflation. Based on the evidence to date, I think that money growth is an important determinant of inflation over longer periods of time.3 The papers in this volume elaborate on that evidence, improving our knowledge of how inflation and money growth are linked. Overall, I also think this volume goes some way to bolstering the argument that monetary developments can be informative for monetary policy, as they are at the ECB, and that it is a mistake to ignore money growth. References Dwyer Jr., G.P., 1999. How was Milton Friedman distinctive as a teacher? In: Hammond, D. (Ed.), In The Intellectual Legacy of Milton Friedman, vol. 1 Edward Elgar Publishing Limited, Cheltenham, United Kingdom, pp. 3–8. Friedman, M. (Ed.), 1956. Studies in the Quantity Theory of Money. University of Chicago Press, Chicago. Friedman, M., 1953. The case for flexible exchange rates. In: Essays in Positive Economics. University of Chicago Press, Chicago, pp. 157–203. Kishor, N.K., Kochin, L.A., 2007. The success of the fed and the death of monetarism. Economic Inquiry 45 (1), 56–70.
Gerald P. Dwyer Research Department, Federal Reserve Bank of Atlanta, 1000 Peachtree St., N.E. Atlanta, GA 30039, USA Universidad Carlos III de Madrid Departamento de Economı´a de la Empresa, Calle Madrid, 126, 28903 Getafe, Madrid, Spain E-mail address: [email protected]
2 3
‘‘Lower frequency variation’’ is roughly the same as ‘‘longer run variation’’. I imagine that most or all of the authors in this volume would agree, but I would not pretend to speak for them.