[Publisher:] Institut für Weltwirtschaft (IfW) [Place:] Kiel [Year:] 1988
Kiel Working Paper No. 338
Money supply targeting has come out of fashion. The large changes in velocity in some countries and the fact that inflation is still low in spite of the strong monetary expansion in most industrial economies since 1985 have undermined the formerly accepted notion of a stable relationship between money and economic activity. In this paper, the most important objections to money supply targeting are discussed. Furthermore, alternative indicators for monetary policy, e.g., interest rates and raw material prices, are analyzed; they seem to have serious weaknesses. A closer look at the relationship between money and economic activity reveals that in most countries the volatility of velocity is no more pronounced than in earlier years. Only in a few countries the relationship is disturbed. However, this is largely due to changes in the financial system which were partly caused by high and volatile inflation rates. Therefore, we argue that a case for monetary rules can still be made. Some rules which have been proposed in the literature are designed to adjust to trend changes in velocity. Simulations suggest that if central banks had followed such rules, economic performance would have improved substantially. We conclude that it would be desirable to implement a rule-based policy in industrial countries and suggest that rules should be enforced by law.