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Monetary Policy with State Contingent Interest Rates

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  • Pedro Teles
  • Bernardino Adao
  • Isabel Correia

Abstract

What instruments of monetary policy must be used in order to implement a unique equilibrium? This paper revisits the issues addressed by Poole (1970) and Sargent and Wallace (1975) on the multiplicity of equilibria when policy is conducted with either interest rate or money supply rules. We show that if monetary policy is conducted with both interest rates and money supplies as independent instruments it is possible to implement a unique equilibrium. This policy may require the government to set interest rates for all dates and states and in addition set exogenously the money supply every period in some, but not all, states. We show that an alternative policy that would implement a unique equilibrium sets exogenously the state contingent nominal interest rates as well as the initial money supply. These results hold whether prices are flexible or set in advance.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2004 Meeting Papers with number 813.

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Date of creation: 2004
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Handle: RePEc:red:sed004:813

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Keywords: Monetary policy; policy instruments; sticky prices; state-contingent interest rates.;

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References

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  1. Buera, Francisco & Nicolini, Juan Pablo, 2004. "Optimal maturity of government debt without state contingent bonds," Journal of Monetary Economics, Elsevier, Elsevier, vol. 51(3), pages 531-554, April.
  2. Gaetano Bloise & J. H. Dreze & H. M. Polemarchakis, 2003. "Monetary Equilibria over an Infinite Horizon," Discussion Papers 03-19, University of Copenhagen. Department of Economics.
  3. Carlstrom, Charles T. & Fuerst, Timothy S., 2001. "Timing and real indeterminacy in monetary models," Journal of Monetary Economics, Elsevier, Elsevier, vol. 47(2), pages 285-298, April.
  4. Tomoyuki Nakajima & Herakles Polemarchakis, 2005. "Money and Prices Under Uncertainty," Review of Economic Studies, Oxford University Press, vol. 72(1), pages 223-246.
  5. DREZE, Jacques & POLEMARCHAKIS, Heracles, 2000. "Monetary equilibria," CORE Discussion Papers, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE) 2000044, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  6. repec:fth:louvco:0044 is not listed on IDEAS
  7. Bernardino Adao & Isabel Correia & Pedro Teles, 2003. "Gaps and Triangles," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 70(4), pages 699-713, October.
  8. Bennett T. McCallum, 1982. "Price Level Determinacy with an Interest Rate Policy Rule and Rational Expectations," NBER Working Papers 0559, National Bureau of Economic Research, Inc.
  9. Sargent, Thomas J & Wallace, Neil, 1975. ""Rational" Expectations, the Optimal Monetary Instrument, and the Optimal Money Supply Rule," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 83(2), pages 241-54, April.
  10. George-Marios Angeletos, 2002. "Fiscal Policy With Noncontingent Debt And The Optimal Maturity Structure," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 117(3), pages 1105-1131, August.
  11. Lawrence J. Christiano & Massimo Rostagno, 2001. "Money Growth Monitoring and the Taylor Rule," NBER Working Papers 8539, National Bureau of Economic Research, Inc.
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Cited by:
  1. Adao, Bernardino & Correia, Maria Isabel Horta & Teles, Pedro, 2005. "Monetary Policy with Single Instrument Feedback Rules," CEPR Discussion Papers, C.E.P.R. Discussion Papers 4948, C.E.P.R. Discussion Papers.
  2. Carlos Garcia & Wildo Gonzalez, 2010. "Is more exchange rate intervention necessary in small open economies? The role of risk premium and commodity shocks," ILADES-Georgetown University Working Papers, Ilades-Georgetown University, Universidad Alberto Hurtado/School of Economics and Bussines inv248, Ilades-Georgetown University, Universidad Alberto Hurtado/School of Economics and Bussines.

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