Money and Financial Markets
As a tool of monetary policy, changing interest rates is only the means to an end. One (some would say the only) goal of monetary policy is low, steady inflation. How can we tell if monetary policy is on track for that a goal? One way is to look directly at money; after all, the textbook cause of inflation is “too much money chasing too few goods.” If more money is created than the amount people are willing to hold, prices can rise. A simple model of money demand predicted future inflation effectively in the late 1990s but has done poorly since. The amount of money people are willing to hold varies considerably, which makes excess money a poor gauge of future inflation.
Suggested citation: "Money and Financial Markets," Federal Reserve Bank of Cleveland, Economic Trends, no. 03-01, pp. 05-07, 01.01.2003.