Discussion Paper

No. 2009-29 | June 18, 2009
The Design of a `Two-Pillar´ Monetary Policy Strategy


In this paper, it is argued that money supply in a narrow sense and repo interest rate are two independent monetary policy instruments when the effect of interest rate policy cannot be efficiently transmitted to the economy through the monetary and financial markets. In this case, the control of money supply is necessary to reduce the discrepancy between the repo interest rate and the interest rates at which private agents lend and borrow. Using a simple macro-economic model, this study shows how a two-pillar monetary policy strategy as practiced by the European central bank (ECB) can be conceived to guarantee macroeconomic stability and the credibility of monetary policy. This strategy can be interpreted as a combination of inflation targeting and monetary targeting. Well conceived monetary targeting with a commitment to a long-run money growth rate corresponding to inflation target could reinforce the credibility of central bank announcements and the role of inflation target as strong and credible nominal anchor for private inflation expectations. However, an inflation-targeting regime associated with Friedman’s money supply rule can generate dynamic instability in output, inflation and money demand. Three feedback monetary targeting rules, of which the design depends on economic structure and central bank preferences, are discussed relative to their capability of warranting macroeconomic stability.

JEL Classification:

E44, E52, E58


  • Downloads: 3066


Cite As

Meixing Dai (2009). The Design of a `Two-Pillar´ Monetary Policy Strategy. Economics Discussion Papers, No 2009-29, Kiel Institute for the World Economy. http://www.economics-ejournal.org/economics/discussionpapers/2009-29

Comments and Questions

Anonymous - Referee Report
June 23, 2009 - 08:41

see attached file

Meixing Dai - Reply to Referee Report 1
July 01, 2009 - 19:26

See the attached file.

Charles Goodhart - Reader Comment
July 14, 2009 - 08:40

see attached file

Meixing Dai - Reply to the Comment by Charles Goodhart
July 16, 2009 - 13:48

See attached file