DP3689 The ECB's Two Pillars

• Stefan Gerlach
28 Jan 2003

This Paper suggests a formal interpretation of the ECB?s two-pillar framework for monetary policy. I decompose inflation in the euro area
into high- and low-frequency (or short-run and medium/long-run) components, which are correlated with monetary growth and the output gap, respectively. I proceed to propose and estimate a ?two-pillar? Phillips curve that assumes that money causes prices. While the model fits well and the causality assumption seems compatible with the 1980-90 data, there appears to be reverse causality from prices to money in the 1991-2001 period, which would invalidate my model.