 The optimal monetary instrument and the (mis)use of causality testsJohn W. Keating and A. Lee Smith Journal of Financial Stability, 2019, vol. 42, issue C, 90-99 Abstract: This paper investigates the optimal monetary instrument in a New-Keynesian model with multiple monetary assets. We compare a standard interest rate rule to a k-percent rule for three alternative monetary aggregates determined within our model: the monetary base, the simple sum measure of money, and the Divisia measure. Welfare results are striking. While the interest rate dominates the other two monetary aggregate k-percent rules, the Divisia k-percent rule outperforms the interest rate rule. Next we study the ability of Granger Causality tests – in the context of data generated from our model – to correctly identify welfare improving instruments. We find the interest rate Granger Causes both output and prices at extremely high significance levels. The same result is obtained for monetary base and the simple-sum monetary aggregate. The test results for Divisia are the weakest as Divisia fails to Granger Cause prices. We conclude that if the choice of instrument is based solely on its propensity to Granger Cause macroeconomic targets, a central bank may choose an inferior policy instrument. Keywords: Monetary policy instrument; Monetary aggregates; Granger Causality (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:eee:finsta:v:42:y:2019:i:c:p:90-99 DOI: 10.1016/j.jfs.2019.05.011 Access Statistics for this article Journal of Financial Stability is currently edited by I. Hasan, W. C. Hunter and G. G. Kaufman More articles in Journal of Financial Stability from Elsevier |
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