Interest Rates and Money in the Measurement of Monetary Policy

There is a very interesting, new study by Michael T. Belongia and Peter N. Ireland on interest rates and Divisia aggregates in the measurement of monetary policy.

Peter Ireland is a professor of economics at Boston College; a research associate at the National Bureau of Economic Research; and a member of the Shadow Open Market Committee. Michael Belongia is a professor of economics at the University of Mississippi and prior to that was a research economist and economic adviser at the Federal Reserve Bank of St. Louis.


Over the last twenty-five years, a set of influential studies has placed interest rates at the heart of analyses that interpret and evaluate monetary policies. In light of this work, the Federal Reserve’s recent policy of “quantitative easing,” with its goal of affecting the supply of liquid assets, appears to be a radical break from standard practice. Alternatively, one could posit that the monetary aggregates, when measured properly, never lost their ability to explain aggregate fluctuations and, for this reason, represent an important omission from standard models and policy discussions. In this context, the new policy initiatives can be characterized simply as conventional attempts to increase money growth. This view is supported by evidence that superlative (Divisia) measures of money often help in forecasting movements in key macroeconomic variables. Moreover, the statistical fit of a structural vector autoregression deteriorates significantly if such measures of money are excluded when identifying monetary policy shocks. These results cast doubt on the adequacy of conventional models that focus on interest rates alone. They also highlight that all monetary disturbances have an important “quantitative” component, which is captured by movements in a properly measured monetary aggregate.

CFS Comment: In a well known paper, Bernanke and Blinder (1988) argued that central bank policy targeting credit supply is more stabilizing than monetary policy targeting money supply, if credit demand is more stable than money demand, and visa versa. But the large shocks to credit demand that have occurred since 2007 have caused credit markets to become conspicuously unstable, suggesting that we now are in an environment in which focus on money supply has become more important than focus on credit supply.

Click here to read “Interest Rates and Money in the Measurement of Monetary Policy.”