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Money Supply and the Implementation of Interest Rate Targets

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  • Andreas Schabert

    ()
    (Faculty of Economics and Econometrics, Universiteit van Amsterdam)

Abstract

In this paper, we analyze the relation between interest rate targets and money supply in a (bubble-free) rational expectations equilibrium of a standard cash-in-advance model. We examine lump-sum injections of money aimed to implement interest rate sequences that satisfy interest rate target rules. An interest rate target with a positive inflation feedback in general corresponds to money growth rates rising with inflation. When prices are not completely flexible, this implies that a non-destabilizing money supply cannot implement a forward-looking and active interest rate rule. This principle also applies for an alternative model version with an interest elastic money demand. The implementation of a Taylor-rule then requires money injections that lead to explosive or oscillatory equilibrium sequences. In contrast, an inertial interest rate target can be implemented by a non-destabilizing money supply, even if the inflation feedback exceeds one, which is often found in interest rate rule regressions.

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Bibliographic Info

Paper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 05-059/2.

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Date of creation: 08 Jun 2005
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Handle: RePEc:dgr:uvatin:20050059

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Web page: http://www.tinbergen.nl

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Keywords: Interest rate rules; contingent money supply; macroeconomic stability; policy equivalence; interest rate inertia;

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Citations

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Cited by:
  1. Auray, Stéphane & Fève, Patrick, 2008. "On the observational (non)equivalence of money growth and interest rate rules," Journal of Macroeconomics, Elsevier, Elsevier, vol. 30(3), pages 801-816, September.
  2. Schabert, Andreas & van Wijnbergen, Sweder, 2006. "Debt, Deficits and Destabilizing Monetary Policy in Open Economies," CEPR Discussion Papers, C.E.P.R. Discussion Papers 5590, C.E.P.R. Discussion Papers.
  3. Andreas Schabert, 2006. "Central Bank Instruments, Fiscal Policy Regimes, and the Requirements for Equilibrium Determinacy," Tinbergen Institute Discussion Papers 06-025/2, Tinbergen Institute.
  4. Schabert, Andreas, 2005. "Discretionary Policy, Multiple Equilibria, and Monetary Instruments," CEPR Discussion Papers, C.E.P.R. Discussion Papers 5400, C.E.P.R. Discussion Papers.
  5. Schabert, Andreas, 2009. "Money supply, macroeconomic stability, and the implementation of interest rate targets," Journal of Macroeconomics, Elsevier, Elsevier, vol. 31(2), pages 333-344, June.

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