DP6097 Money in Monetary Policy Design: A Formal Characterization of ECB-Style Cross-Checking

Author(s): Günter Beck, Volker Wieland
Publication Date: February 2007
Keyword(s): European Central Bank, monetary policy, monetary policy under uncertainty, money, quantity theory
JEL(s): E32, E41, E43, E52, E58
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=6097

The European Central Bank has assigned a special role to money in its two pillar strategy and has received much criticism for this decision. The case against including money in the central bank's interest rate rule is based on a standard model of the monetary transmission process that underlies many contributions to research on monetary policy in the last two decades. In this paper, we develop a justification for including money in the interest rate rule by allowing for imperfect knowledge regarding unobservables such as potential output and equilibrium interest rates. We formulate a novel characterization of ECB-style monetary cross-checking and show that it can generate substantial stabilization benefits in the event of persistent policy misperceptions regarding potential output.