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Money Supply and the Implementation of Interest Rate Targets

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Author Info
Andreas Schabert () (Faculty of Economics and Econometrics, Universiteit van Amsterdam)

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

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Find related papers by JEL classification:
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Schabert, Andreas, 2005. "Discretionary Policy, Multiple Equilibria, and Monetary Instruments," CEPR Discussion Papers 5400, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  2. Andreas Schabert & Sweder van Wijnbergen, 2006. "Debt, Deficits, and Destabilizing Monetary Policy in Open Economies," Tinbergen Institute Discussion Papers 06-045/2, Tinbergen Institute. [Downloadable!]
    Other versions:
  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. [Downloadable!]
    Other versions:
  4. Henri Pagès & David Humphrey, 2005. "Settlement finality as a public good in large-value payment systems," Working Paper Series 506, European Central Bank. [Downloadable!]
    Other versions:
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