The future of monetary aggregates in monetary policy analysis

This paper considers the role of monetary aggregates in modern macroeconomic models of the New Keynesian type. The focus is on future model developments that are suggested by the monetarist literature, and that in addition seem justified empirically. Both the relation between money and inflation, and between money and aggregate demand, are considered. Regarding the first relation, it is argued that both the mean and the dynamics of inflation in present-day models are governed by money growth. This arises from a conventional aggregate-demand channel; claims that an emphasis on the link between monetary aggregates and inflation requires a direct channel connecting money to inflation, are wide of the mark. The relevance of money for aggregate demand, in turn, comes not via real balance effects (or other justifications for money in the IS equation), but on money serving as a proxy for the various substitution effects of monetary policy that exist when many asset prices matter for aggregate demand. This role for monetary aggregates is supported by empirical evidence and enhances the value of money to monetary policy.