**Seminar Papers, Institute for International Economic Studies, Stockholm University**
# No 632:

Doing Without Money: Controlling Inflation in a Post-Monetary World

*Michael Woodford*
**Abstract:** Central banks now generally agree that conventional
monetary aggregates are of little use as targets or even indicators for
monetary policy, owing to the instability of money demand relations in
economies with well-developed financial markets. But monetary theory has
provided little guidance for the analysis of policies that are not
formulated in terms of a path for the money supply, and a stable money
demand relation is generally assumed as a central element of a theoretical
analysis. This paper, instead, shows that it is possible to analyze
equilibrium inflation determination without any reference to either money
supply or demand, as long as one specifies policy in terms of a
'Wicksellian' interest-rate feedback rule.

The paper's central result is
an approximation theorem, showing the existence, for a simple monetary
model, of a well-behaved 'cashless limit' in which the money balances held
to facilitate transactions become negligible. The relations that determine
equilibrium inflation in the cashless limit also provide a useful
approximate account in the case of an economy in which monetary frictions
are present, but small. The approximation remains valid in the case of time
variation in the monetary frictions, including variation of a kind that may
result in substantial instability of money demand in percentage terms.

Inflation in the cashless limit is shown to be a function of the gap
between the 'natural rate' of interest, determined by the supply of goods
and opportunities for intertemporal substitution, and a time-varying
parameter of the interest-rate rule indicating the tightness of monetary
policy. Inflation can be completely stabilized, in principle, by adjusting
the policy parameter so as to track variation in the natural rate. Under
such a regime, instability of money demand has little effect upon
equilibrium inflation, and need not be monitored by the central bank.

**Keywords:** interest-rate feedback; cashless limit; (follow links to similar papers)

**JEL-Codes:** E42; E52; E58; (follow links to similar papers)

62 pages, November 6, 1997

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