A reconsideration of money growth rules

A New Keynesian model, estimated using Bayesian methods over a sample period that includes the 2009-15 episode of zero nominal interest rates, illustrates the effects of replacing the Federal Reserve’s historical policy of interest rate management with one targeting money growth instead. Counterfactual simulations show that a rule for adjusting the money growth rate, modestly and gradually, in response to changes in the output gap delivers performance comparable to the estimated interest rate rule in stabilizing output and inflation. The simulations also reveal that, under the same money growth rule, the US economy would have recovered more quickly from the 2007-9 recession, with a much shorter period of exceptionally low interest rates. These results suggest that money growth rules can serve as simple but useful guides for monetary policy and eliminate concerns about monetary policy effectiveness when the zero lower bound constraint is binding.