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Price Level Determinacy with an Interest Rate Policy Rule and Rational Expectations

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  • Bennett T. McCallum

Abstract

This paper reconsiders a result obtained by Sargent and Wallace, namely, that price level indeterminacy obtains in their well-known model if the monetary authorities adopt a policy feedback rule for the interest rate rather than the money stock. Since the Federal Reserve seems often to have used the federal funds rate as its operating instrument, with the money stack determined by the quantity demanded, this result suggests that the Sargent-Wallace model -- as well as others incorporating rational expectations -- is inconsistent with U.S. experience. It is here shown, however, that the indeterminacy result vanishes if the interest rate rule is chosen so as to have some desired effect on the expected quantity of money demanded. This revised conclusion holds even if considerable weight is given, in the choice of a rule, to the aim of smoothing interest rate fluctuations.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 0559.

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Date of creation: Feb 1982
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Publication status: published as McCallum, Bennett T. "Price Level Determinacy With an Interest Rate Policy Rule and Rational Expectations." Journal of Monetary Economics, Vol. 8, No. 3, (November 1981), pp. 319-329.
Handle: RePEc:nbr:nberwo:0559

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  1. Volcker, Paul A., 1978. "The role of monetary targets in an age of inflation," Journal of Monetary Economics, Elsevier, Elsevier, vol. 4(2), pages 329-339, April.
  2. Barro, Robert J, 1974. "Are Government Bonds Net Wealth?," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 82(6), pages 1095-1117, Nov.-Dec..
  3. John H. Kareken & Preston J. Miller, 1976. "The policy procedure of the FOMC: a critique," Working Papers, Federal Reserve Bank of Minneapolis 63, Federal Reserve Bank of Minneapolis.
  4. Franco Modigliani, 1977. "The monetarist controversy; or, should we forsake stabilization policies?," Economic Review, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco, issue Spr suppl, pages 27-46.
  5. Lucas, Robert E, Jr, 1973. "Some International Evidence on Output-Inflation Tradeoffs," American Economic Review, American Economic Association, American Economic Association, vol. 63(3), pages 326-34, June.
  6. Milton Friedman, 1971. "A Theoretical Framework for Monetary Analysis," NBER Books, National Bureau of Economic Research, Inc, number frie71-1.
  7. William Poole, 1970. "Optimal choice of monetary policy instruments in a simple stochastic macro model," Staff Studies, Board of Governors of the Federal Reserve System (U.S.) 57, Board of Governors of the Federal Reserve System (U.S.).
  8. Benjamin M. Friedman, 1977. "The Inefficiency of Short-Run Monetary Targets for Monetary Policy," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 8(2), pages 293-346.
  9. Phelps, Edmund S & Taylor, John B, 1977. "Stabilizing Powers of Monetary Policy under Rational Expectations," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 85(1), pages 163-90, February.
  10. Flood, Robert P & Garber, Peter M, 1980. "Market Fundamentals versus Price-Level Bubbles: The First Tests," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 88(4), pages 745-70, August.
  11. Poole, William, 1975. "The Making of Monetary Policy: Description and Analysis," Economic Inquiry, Western Economic Association International, Western Economic Association International, vol. 13(2), pages 253-65, June.
  12. McCallum, Bennett T, 1978. "Price Level Adjustments and the Rational Expectations Approach to Macroeconomic Stabilization Policy," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 10(4), pages 418-36, November.
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  1. 'A Century of U.S. Central Banking: Goals, Frameworks, Accountability'
    by Mark Thoma in Economist's View on 2013-07-10 13:48:26
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