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Friedman's Money Supply Rule vs. Optimal Interest Rate Policy

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  • George W. Evans
  • Seppo Honkapohja

Abstract

Using New Keynesian models, we compare Friedman's "k"-percent money supply rule to optimal interest rate setting, with respect to determinacy, stability under learning and optimality. First we review the recent literature: open-loop interest rate rules are subject to indeterminacy and instability problems, but a properly chosen expectations-based rule yields determinacy and stability under learning, and implements optimal policy. We show that Friedman's rule also can generate equilibria that are determinate and stable under learning. However, computing the mean quadratic welfare loss, we find for calibrated models that Friedman's rule performs poorly when compared to the optimal interest rate rule. Copyright (c) Scottish Economic Society 2003.

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Bibliographic Info

Article provided by Scottish Economic Society in its journal Scottish Journal of Political Economy.

Volume (Year): 50 (2003)
Issue (Month): 5 (November)
Pages: 550-566

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Handle: RePEc:bla:scotjp:v:50:y:2003:i:5:p:550-566

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  1. James Bullard & Kaushik Mitra, 2007. "Determinacy, Learnability, and Monetary Policy Inertia," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(5), pages 1177-1212, 08.
  2. Lars E.O. Svensson, 1998. "Inflation Targeting as a Monetary Policy Rule," NBER Working Papers 6790, National Bureau of Economic Research, Inc.
  3. Bullard, James & Mitra, Kaushik, 2002. "Learning about monetary policy rules," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1105-1129, September.
  4. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," CEPR Discussion Papers 2139, C.E.P.R. Discussion Papers.
  5. George W. Evans & Seppo Honkapohja, 2002. "Policy Interaction, Learning and the Fiscal Theory of Prices," University of Oregon Economics Department Working Papers 2002-17, University of Oregon Economics Department, revised 07 Jun 2007.
  6. Ben S. Bernanke & Michael Woodford, 1997. "Inflation forecasts and monetary policy," Proceedings, Federal Reserve Bank of Cleveland, pages 653-686.
  7. Howitt, Peter, 1992. "Interest Rate Control and Nonconvergence to Rational Expectations," Journal of Political Economy, University of Chicago Press, vol. 100(4), pages 776-800, August.
  8. Michael Woodford, 1999. "Commentary : how should monetary policy be conducted in an era of price stability?," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 277-316.
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Cited by:
  1. Schabert, Andreas & Stoltenberg, Christian, 2005. "Money demand and macroeconomic stability revisited," Working Paper Series 0458, European Central Bank.
  2. Guender, Alfred V., 2003. "Optimal discretionary monetary policy in the open economy: Choosing between CPI and domestic inflation as target variables," Research Discussion Papers 12/2003, Bank of Finland.
  3. David T. Llewellyn & David G. Mayes, 2004. "The role of market discipline in handling problem banks," Finance 0404020, EconWPA.
  4. Andreas Schabert, 2005. "Money Supply and the Implementation of Interest Rate Targets," Tinbergen Institute Discussion Papers 05-059/2, Tinbergen Institute.
  5. Jukka Vauhkonen, 2004. "Financial contracts and contingent control rights," Finance 0404022, EconWPA.
  6. Jukka Vauhkonen, 2004. "Banks' equity stakes in borrowing firms: A corporate finance approach," Game Theory and Information 0404003, EconWPA.
  7. Schabert, Andreas, 2005. "Discretionary policy, multiple equilibria, and monetary instruments," Working Paper Series 0533, European Central Bank.
  8. Martin ZUMPE (GREThA UMR CNRS 5113), 2010. "Monetary Policy Rules, Learning and Stability: a Survey of the Recent Literature (In French)," Cahiers du GREThA 2010-01, Groupe de Recherche en Economie Théorique et Appliquée.

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