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Friedman's money supply rule vs optimal interest rate policy

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Author Info

  • Evans, George W.

    (University of Oregon)

  • Honkapohja, Seppo

    (University of Helsinki)

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. We first 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 then show that Friedman’s rule also can generate equilibria that are determinate and stable under learning. However, in computing the mean quadratic welfare loss, we find that for calibrated models Friedman’s rule performs poorly compared to the optimal interest rate rule.

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File URL: http://www.suomenpankki.fi/en/julkaisut/tutkimukset/keskustelualoitteet/Documents/0310.pdf
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Bibliographic Info

Paper provided by Bank of Finland in its series Research Discussion Papers with number 10/2003.

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Length: 25 pages
Date of creation: 14 Apr 2003
Date of revision:
Handle: RePEc:hhs:bofrdp:2003_010

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Postal: Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland
Web page: http://www.suomenpankki.fi/en/
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Related research

Keywords: monetary policy; determinacy; stability under learning;

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References

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  1. Svensson, Lars E. O., 1998. "Inflation targeting as a monetary policy rule," CFS Working Paper Series 1998/16, Center for Financial Studies (CFS).
  2. 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.
  3. Bernanke, Ben S & Woodford, Michael, 1997. "Inflation Forecasts and Monetary Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(4), pages 653-84, November.
  4. 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.
  5. James Bullard & Kaushik Mitra, 2002. "Learning about monetary policy rules," Working Papers 2000-001, Federal Reserve Bank of St. Louis.
  6. Kaushik Mitra & James Bullard, 2004. "Determinacy, Learnability, and Monetary Policy Inertia," Royal Holloway, University of London: Discussion Papers in Economics 04/14, Department of Economics, Royal Holloway University of London, revised Jul 2004.
  7. 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.
  8. Richard Clarida & Jordi Galí & Mark Gertler, 1997. "The science of monetary policy: A new Keynesian perspective," Economics Working Papers 356, Department of Economics and Business, Universitat Pompeu Fabra, revised Apr 1999.
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Citations

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Cited by:
  1. Andreas Schabert, 2005. "Money Supply and the Implementation of Interest Rate Targets," Tinbergen Institute Discussion Papers 05-059/2, Tinbergen Institute.
  2. Schabert, Andreas & Stoltenberg, Christian, 2005. "Money demand and macroeconomic stability revisited," Working Paper Series 0458, European Central Bank.
  3. Jukka Vauhkonen, 2004. "Banks' equity stakes in borrowing firms: A corporate finance approach," Game Theory and Information 0404003, EconWPA.
  4. 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.
  5. David T. Llewellyn & David G. Mayes, 2004. "The role of market discipline in handling problem banks," Finance 0404020, EconWPA.
  6. Andreas Schabert, 2005. "Discretionary Policy, Multiple Equilibria, and Monetary Instruments," Tinbergen Institute Discussion Papers 05-098/2, Tinbergen Institute.
  7. Alfred V. Guender, 2004. "Optimal discretionary monetary policy in the open economy: Choosing between CPI and domestic inflation as target variables," Macroeconomics 0404038, EconWPA.
  8. Jukka Vauhkonen, 2004. "Financial contracts and contingent control rights," Finance 0404022, EconWPA.

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