Inflation, Monetary Policy and Monetary Aggregates

Abstract

Taxonomically speaking, the received theories of the macroeconomy may be said to comprise monetarism, structuralism, Marxism, the post-Keynesian view and the New Consensus Macroeconomics (NCM).  However, in the last few decades, the mainstream view has been converging on the NCM, representing a grafting of essentially Keynesian ideas on a framework of rational expectations. Associated with this consensus has been a steady de-emphasis on the role of monetary aggregates in the framing of monetary policy. This paper is devoted to an examination of the role of monetary aggregates in each of the macroeconomic theories listed above. In particular, it contests the prevailing mainstream policy viewpoint (heavily influenced by the NCM) that monetary aggregates have no explanatory power for inflation beyond that contained in the output gap.  On the contrary, the empirical fact that several monetary shocks originate on the supply side, coupled with the strong possibility of monetary shocks affecting output through relative price changes, make out a strong case for the inclusion of monetary aggregates at least as a Second Pillar of monetary policy  (in the manner currently done at the European Central Bank). A monetary policy calibrated without reference to monetary aggregates is like Hamlet without the Prince of Denmark.