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Central bank Instruments, Fiscal Policy Regimes, and the Requirements for Equilibrium Determinacy

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  • Andreas Schabert

Abstract

In this paper we examine the local determinacy conditions for three monetary policy regimes in a business cycle model with staggered price setting. The central bank either controls the nominal interest rate, the money growth rate, or it conducts open market operations and controls the bond-to-money ratio herein. All instruments are set contingent on changes in current inflation. For the first two cases, equilibrium determinacy imposes strong restrictions on the endogenous response to changes in inflation, which depend on whether fiscal policy is Ricardian or non-Ricardian. In the case of open market policy, Ricardian equivalence does not hold and government solvency is guaranteed for finite bond-to- money ratios. The central bank can ensure determinacy by setting the latter not in an extremely reactive way. The equilibrium sequence of real financial wealth then exerts a stabilizing impact on prices and real activity such that equilibrium multiplicity as well as explosiveness is ruled out.

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Paper provided by Business School - Economics, University of Glasgow in its series Working Papers with number 2003_5.

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Date of revision: Jan 2003
Handle: RePEc:gla:glaewp:2003_5

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Cited by:
  1. Chowdhury, Ibrahim & Schabert, Andreas, 2008. "Federal reserve policy viewed through a money supply lens," Journal of Monetary Economics, Elsevier, vol. 55(4), pages 825-834, May.
  2. Schabert, Andreas, 2009. "Money supply, macroeconomic stability, and the implementation of interest rate targets," Journal of Macroeconomics, Elsevier, vol. 31(2), pages 333-344, June.
  3. Stefan Niemann & Paul Pichler & Gerhard Sorger, 2010. "Central bank independence and the monetary instrument problem," Economics Discussion Papers 687, University of Essex, Department of Economics.
  4. Auray, Stéphane & Fève, Patrick, 2008. "On the observational (non)equivalence of money growth and interest rate rules," Journal of Macroeconomics, Elsevier, vol. 30(3), pages 801-816, September.
  5. Ibrahim Chowdhury & Andreas Schabert, 2008. "Federal Reserve Policy viewed through a Money Supply Loss," Tinbergen Institute Discussion Papers 08-023/2, Tinbergen Institute.

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