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9. Monetary Rules

9. Monetary Rules. Friedman- rule : M.Friedman (1956), The quantity theory of money . A restatement . Studies in Quantitity Theory , Chicago Quantity Equation (e.g. Deutsche Bundesbank, Monatsbericht April 1999)

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9. Monetary Rules

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  1. 9. Monetary Rules Friedman-rule: M.Friedman (1956), The quantitytheoryofmoney. A restatement. Studies in QuantitityTheory, Chicago QuantityEquation (e.g. Deutsche Bundesbank, Monatsbericht April 1999) Taylor-Rule: John B. Taylor: Discretion versus policy rules in practice. In: Carnegie-Rochester Conference Series on Public Policy. Band 39, 1993, S. 195-214. U van Suntum, Lecture KuB 1 KuB

  2. Friedman´s rule(s) • 2%-rule: monetary support of growth in factor supply only => stable factor prices, commodity prices decline => „neutral money“ • 5%-Rule: monetary support of growth both in factor supply (2%) and productivity (3%): factor prices rise, commodity prices stable => „stable money“ U van Suntum, Lecture KuB 2 KuB

  3. Example (with v constant): • production function Yreal = a N productivity growth (3%) growth in factor supply (2%) • quantity equation: M v = Y = Yreal p => p = v M/(aN) • quantity equation: M v = Y = w N => w = v (M/N) • p = v M/(aN) => constant if M/(aN) is constant (5% rule) • w = v (M/N) => constant, if (M/N) is constant (2% rule) U van Suntum, Lecture KuB 3 KuB

  4. ECB follows idea of modified 5%-rule: • commodity prices: inflation rate near to, but below 2% • factor prices (wages): productivity growth plus inflation rate ECB-double pillar strategy • pillar: • Monetarygrowth • pillar: • Inflation targeting U van Suntum, Lecture KuB 4 KuB

  5. 1. pillar: monetary growth U van Suntum, Lecture KuB 5 KuB

  6. Upper bound: 5,5% = 2,5% - (-1,0%) + 2% Lower bound: 4,5% = 2,0% - (-0,5%) + 2% Target value: 4,5% U van Suntum, Lecture KuB 6 KuB

  7. 2. pillar: inflation targeting (multi-indicator concept) monetary forecast Instruments (interest rates) Inflation target (stable prices level) monetary indicators time U van Suntum, Lecture KuB 7 KuB

  8. Taylor-rule output-gap Long term Real interest rate current real GDP potential output Short term prime rate current inflation rate target inflations rate disturbance term inflation gap U van Suntum, Lecture KuB 8 KuB

  9. Interpretation of Taylor-Rule Empiricaldescriptionofcentralbankbehavior normative recommendationforcentralbankpolicy Taylor-rate i = real equilibrium interest rate + expected inflation rate + a * inflation gap + b * output gap i.e. rise in prime rate if inflation or real output are above standard value U van Suntum, Lecture KuB 9 KuB

  10. Taylor-rate and actual interest rate Source: Deutsche Bundesbank, Monatsbericht April 1999 U van Suntum, Lecture KuB 10 KuB

  11. Comparisonof Taylor ruleandquantityequation(see Bundesbank, Monatsbericht März 1999) (actual monetary increase) (target monetary increase) (i.e. interest rate increases if actual above target monetary increase) (* trend or target value U van Suntum, Lecture KuB 11 KuB

  12. Bundesbank: Taylor: • Differencesbetweenquantityequationand Taylor: • guidedbygrowthratesinsteadof absolute targetvalues • guidedbyinterest rate ofpreviousperiodinsteadoflongterm • equilibrium rate • explicit recognitionofchanges in velocityofmoneycirculation U van Suntum, Lecture KuB 12 KuB

  13. Lerning goals/questions • What is the monetary strategy of ECB? • Can you explain the Friedman rules (2% and 5%)? • Can you explain the Taylor rule? • What is the relationship between the Taylor rule and the quantity equation? U van Suntum, Lecture KuB 13 KuB

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