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Real indeterminacy and the timing of money in open economies

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  • Stephen McKnight

    (El Colegio de México)

Abstract

Should central banks target producer price inflation or consumer price inflation in the setting of monetary policy? Previous studies suggest that in order to avoid real indeterminacy and self-fulfilling fluctuations, the interest rate rule for open economies should react to producer price inflation. However, as this paper shows, the preference towards a particular inflation index crucially depends upon the timing assumption on money employed in the determinacy analysis. This timing assumption importantly determines the transactions-facilitating services of money. It is shown that the conclusions of the existing literature, that advocate targeting producer price inflation, is a by-product of adopting end-of-period timing, i.e. what matters for transactions purposes is the money one leaves the goods market with. However, we find that the conditions for equilibrium determinacy change significantly once cash-in-advance timing is adopted, i.e. what matters for current transactions is the money one enters the goods market with. Thus in stark contrast to previous studies, we show that under cash-in-advance timing, targeting consumer price inflation is preferable to targeting producer price inflation in preventing self-fulfilling expectations.

Suggested Citation

  • Stephen McKnight, 2011. "Real indeterminacy and the timing of money in open economies," Serie documentos de trabajo del Centro de Estudios Económicos 2011-01, El Colegio de México, Centro de Estudios Económicos.
  • Handle: RePEc:emx:ceedoc:2011-01
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    File URL: https://cee.colmex.mx/dts/2011/DT-2011-1.pdf
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Stephen McKnight & Alexander Mihailov, 2015. "Do Real Balance Effects Invalidate the Taylor Principle in Closed and Open Economies?," Economica, London School of Economics and Political Science, vol. 82(328), pages 938-975, October.
    2. Fujisaki, Seiya, 2013. "Taylor rules and equilibrium determinacy in a two-country model with non-traded goods," Economic Modelling, Elsevier, vol. 35(C), pages 597-603.
    3. Stephen McKnight, 2011. "Investment and interest rate policy in the open economy," Oxford Economic Papers, Oxford University Press, vol. 63(4), pages 673-699, December.
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    5. Chang Wen-ya & Tsai Hsueh-fang & Chang Juin-jen & Lin Hsieh-yu, 2018. "Interest rate rules and equilibrium (in)determinacy in a small open economy: the role of internationally traded capital," The B.E. Journal of Macroeconomics, De Gruyter, vol. 18(2), pages 1-18, June.
    6. Fujisaki, Seiya, 2012. "Interest Rate Control Rules and Macroeconomic Stability in a Heterogeneous Two-Country Model," MPRA Paper 37017, University Library of Munich, Germany.
    7. repec:rdg:wpaper:em-dp2007-52 is not listed on IDEAS
    8. Fujisaki, Seiya, 2012. "Taylor rules and equilibrium determinacy in a two-country model with non-traded goods," MPRA Paper 40023, University Library of Munich, Germany.
    9. Stephen McKnight & Alexander Mihailov, 2007. "Re-examining the Importance of Trade Openness for Aggregate Instability," Economic Analysis Research Group Working Papers earg-wp2007-12, Henley Business School, University of Reading.
    10. William A. Barnett & Unal Eryilmaz, 2023. "Monetary Policy and Determinacy: An Inquiry into Open Economy New Keynesian Macrodynamics," Open Economies Review, Springer, vol. 34(2), pages 217-253, April.

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    More about this item

    Keywords

    real indeterminacy; open economy monetary models; trade openness; interest rate rules;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E53 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Deposit Insurance
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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