Fixing the Money Stock vs. Fixing the Interest Rate: A VAR Model

Abstract

The "instrument problem" in monetary policy has centered on the question of whether controlling the money stocks or fixing the interest rate is more preferable in terms of higher and more stable output. The former policy implies a stable price level but less investments due to a fluctuating interest rat; the latter implies a more stable investment climate but a volatile price level.

This paper examines the conditions under which either of the two policies would be more suitable for the case of the Philippines. This study uses monthly data on money supply, output, prices, interest rates, and exchange rates for the period 1981-1991. A vector autoregressive model based on a work by Christopher Sims (1980) is used to estimate the parameters. The regression results show that a money-target of the price effects of money-stock changes and the non-significance of the interest rate coefficient in the output equations.