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Friedman's Money Supply Rule versus Optimal Interest Rate Policy

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  • George W. Evans

    ()
    (University of Oregon Economics Department)

  • Seppo Honkapohja

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

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Bibliographic Info

Paper provided by University of Oregon Economics Department in its series University of Oregon Economics Department Working Papers with number 2003-30.

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Length: 21
Date of creation: 01 Oct 2003
Date of revision: 01 Oct 2003
Handle: RePEc:ore:uoecwp:2003-30

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Keywords: monetary policy; determinacy; stability under learning;

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  1. Evans, George W. & Honkapohja, Seppo, 2007. "Policy Interaction, Learning, And The Fiscal Theory Of Prices," Macroeconomic Dynamics, Cambridge University Press, vol. 11(05), pages 665-690, November.
  2. 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.
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Cited by:
  1. Bask, Mikael, 2007. "Optimal monetary policy in a hybrid New Keynesian model with a cost channel," Research Discussion Papers 24/2007, Bank of Finland.
  2. Bask, Mikael, 2007. "Optimal monetary policy under heterogeneity in currency trade," Research Discussion Papers 21/2007, Bank of Finland.
  3. Dai, Meixing, 2011. "Financial market imperfections and monetary policy strategy," Economic Modelling, Elsevier, vol. 28(6), pages 2609-2621.

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