Discussion of "Putting 'M' Back in Monetary Policy"

Abstract

The European Central Bank assigns a prominent role for money and monetary analysis in its monetary policy strategy.' It will therefore not come as a surprise that I am very sympathetic to the general theme of Eric Leeper and Jennifer Roush's paper. Indeed, let us put back in monetary policy. In this paper, Leeper and Roush (2003, this issue of JMCB) show quite convincingly that explicitly allowing for a short-term response of the policy-controlled interest rate to money (M2) rather than to contemporaneous output and prices (as in the Taylor rule) helps identify the effects of exogenous monetary policy shocks in a monthly VAR. It reduces the price and liquidity puzzle, which is so often incurred in this type of exercise. It increases the size and the persistence of the output and price effects of a monetary policy shock. It improves the estimation of the short-run money market supply and demand schedules. And, importantly, these findings appear to be robust across various sub-samples (possibly with the exception of the most recent sub-sample). The bottom line is therefore: Let us put M back in the monetary policy reaction. While I will not disagree with this conclusion and I will provide some additional evidence for the euro area in Section 3 of this discussion, it is worth asking why the estimated effects of policy shocks with a contemporaneous reaction to money are more plausible than those estimated in VARs without such a role for money. First, is the price puzzle really a puzzle? There is no full consensus about this. In particular, one can construct models in which contractionary monetary policy shocks have an initial positive effect on prices due to an interest rate cost channel (e.g., Christiano,