Lawrence J. Christiano

Roberto Motto

Massimo Rostagno

We describe two examples which illustrate in different ways how money and credit may be useful in the conduct of monetary policy. Our first example shows how monitoring money and credit can help anchor private sector expectations about inflation. Our second example shows that a monetary policy that focuses too narrowly on inflation may inadvertently contribute to welfare-reducing boom-bust cycles in real and financial variables. The example is of some interest because it is based on a monetary policy rule fit to aggregate data. We show that a policy of monetary tightening when credit growth is strong can mitigate the problems identified in our second example.

Two Reasons why Money and Credit May be Useful in Monetary Policy

Martin Eichenbaum

Charles Evans

This paper uses the Flow of Funds accounts to assess the impact of a monetary policy shock on the borrowing and lending activities of different sectors of the economy. Our measures of contractionary monetary policy shocks have the following properties: (i) they are associated with a fall in nonborrowed reserves, total reserves, M1, the Federal Reserves' holdings of government securities and a rise in the federal funds rate, (ii) they lead to persistent declines in real GNP, employment, retail sales and nonfinancial corporate profits as well as increases in unemployment and manufacturing inventories, (iii) they generate sharp, persistent declines in commodity prices and (iv) the GDP price deflator does not respond to them for roughly a year. After that the GDP price deflator declines. Our major findings regarding the borrowing activities of different sectors can be summarized as follows. First, following a contractionary shock to monetary policy, net funds raised by the business sector increases for roughly a year. Thereafter, as the recession induced by the policy shock gains momentum, net funds raised by the business sector begins to fall. This pattern is not captured by existing monetary business cycle models. Second, we cannot reject the view that households do not adjust their financial assets and liabilities for several quarters after a monetary shock. This is consistent with a key assumption of several recent monetary business cycle models.

Some Evidence from the Flow of Funds

The Effects of Monetary Policy Shocks

Martin S. Eichenbaum

Robert J. Vigfusson

"This paper investigates the response of hours worked to a permanent technology shock. Based on annual data from Canada, we argue that hours worked rise after a positive technology shock. We obtain a similar result using annual data from the United States. These results contradict a large literature that claims that a positive technology shock causes hours worked to fall. We find that the different results are due to the literature making a specification error in the statistical model of per capital hours worked. Finally, we present results that Canadian monetary policy has accommodated technology shocks"--Federal Reserve Board web site.

Lawrence J. Christiano

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