Real indeterminacy and the timing of money in open economies
AbstractShould central banks target producer price inflation or consumer price inflation in the setting of monetary policy? Previous studies suggest that in order to avoid real indeterminacy and self-fulfilling fluctuations, the interest rate rule for open economies should react to producer price inflation. However, as this paper shows, the preference towards a particular inflation index crucially depends upon the timing assumption on money employed in the determinacy analysis. This timing assumption importantly determines the transactions-facilitating services of money. It is shown that the conclusions of the existing literature, that advocate targeting producer price inflation, is a by-product of adopting end-of-period timing, i.e. what matters for transactions purposes is the money one leaves the goods market with. However, we find that the conditions for equilibrium determinacy change significantly once cash-in-advance timing is adopted, i.e. what matters for current transactions is the money one enters the goods market with. Thus in stark contrast to previous studies, we show that under cash-in-advance timing, targeting consumer price inflation is preferable to targeting producer price inflation in preventing self-fulfilling expectations.
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Bibliographic InfoPaper provided by El Colegio de México, Centro de Estudios Económicos in its series Serie documentos de trabajo del Centro de Estudios Económicos with number 2011-01.
Date of creation: Mar 2011
Date of revision:
real indeterminacy; open economy monetary models; trade openness; interest rate rules;
Other versions of this item:
- Stephen McKnight, 2007. "Real Indeterminacy and the Timing of Money in Open Economies," Economic Analysis Research Group Working Papers earg-wp2007-09, Henley Business School, Reading University.
- Stephen McKnight, 2007. "Real Indeterminacy and the Timing of Money in Open Economies," Economics & Management Discussion Papers em-dp2007-46, Henley Business School, Reading University.
- E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
- E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
- E53 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Deposit Insurance
- E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
- F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-03-19 (All new papers)
- NEP-CBA-2011-03-19 (Central Banking)
- NEP-DGE-2011-03-19 (Dynamic General Equilibrium)
- NEP-MAC-2011-03-19 (Macroeconomics)
- NEP-MON-2011-03-19 (Monetary Economics)
- NEP-OPM-2011-03-19 (Open Economy Macroeconomic)
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.:
- De Fiore, Fiorella & Liu, Zheng, 2005. "Does trade openness matter for aggregate instability?," Journal of Economic Dynamics and Control, Elsevier, vol. 29(7), pages 1165-1192, July.
- Fujisaki, Seiya, 2012. "Taylor rules and equilibrium determinacy in a two-country model with non-traded goods," MPRA Paper 40023, University Library of Munich, Germany.
- Stephen McKnight, 2011.
"Investment and interest rate policy in the open economy,"
Oxford Economic Papers,
Oxford University Press, vol. 63(4), pages 673-699, December.
- Stephen McKnight, 2007. "Investment and Interest Rate Policy in the Open Economy," Economic Analysis Research Group Working Papers earg-wp2007-11, Henley Business School, Reading University.
- Stephen McKnight, 2011. "Investment and interest rate policy in the open economy," Serie documentos de trabajo del Centro de Estudios EconÃ³micos 2011-02, El Colegio de México, Centro de Estudios Económicos.
- Fujisaki, Seiya, 2012. "Interest Rate Control Rules and Macroeconomic Stability in a Heterogeneous Two-Country Model," MPRA Paper 37017, University Library of Munich, Germany.
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