Monetary policy: Why money matters (and interest rates don’t)

Since the late 1980s the Fed has implemented monetary policy by adjusting its target for the overnight federal funds rate. Money’s role in monetary policy has been tertiary, at best. Indeed, several influential economists suggest that money is irrelevant for monetary policy because central banks affect economic activity and inflation by (i) controlling a very short-term nominal interest rate and (ii) influencing financial market participants’ expectation of the future policy rate. I offer an alternative perspective: Money is essential for monetary policy because it is essential for controlling the price level, and the monetary authority’s ability to control interest rates is greatly exaggerated.