Is There an Active Role for Monetary Policy in the Endogenous Money Approach?

Abstract

In the last two decades or so monetary policy has gained the most prominent role in the economic policy debate. More importantly, academics and policy makers have abandoned the targeting of monetary aggregates, generally considered not to be co-integrated with nominal income, and are now engaged in unison in aggregate demand fine tuning through interest rate management. This is what Laurence Meyer, a member of the Board of Governors of the Federal Reserve System, has defined as the new consensus view on macroeconomics (2001). The aggregate demand fine tuning is understood to work through changes in the output gap. The story goes as follows. Changes in real factors such as population, investment in physical and human capital, and technology determine the growth of potential real GDP. Changes in consumption, investment, government expenditure, and net exports determine the growth of aggregate demand. Then, when aggregate demand is greater than potential real GDP, inflation pressures are generated. The reverse holds when aggregate demand grows too slowly. By changing the short-term nominal interest rate, central banks can then bring the growth of aggregate demand in line with the growth of potential output. In the new consensus view, inflation is thus a proxy for the state of economic balance. It is an outcome summary statistic describing the gap between current and potential output. To put it bluntly, changes in the rate of inflation, and the resulting changes in the interest rate set exogenously by the central bank, are the pri-