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Using a long-term interest rate as the monetary policy instrument

  • Bruce McGough
  • Glenn D. Rudebusch
  • John C. Williams

Using a short-term interest rate as the monetary policy instrument can be problematic near its zero bound constraint. An alternative strategy is to use a long-term interest rate as the policy instrument. We find when Taylor-type policy rules are used to set the long rate in a standard New Keynesian model, indeterminacy--that is, multiple rational expectations equilibria--may often result. However, a policy rule with a long rate policy instrument that responds in a "forward-looking" fashion to inflation expectations can avoid the problem of indeterminacy.

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Paper provided by Federal Reserve Bank of San Francisco in its series Working Paper Series with number 2004-22.

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Date of creation: 2004
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Publication status: Published in Journal of Monetary Economics, v. 52, no. 5 (July 2005) pp. 855-879
Handle: RePEc:fip:fedfwp:2004-22
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  9. Okina, Kunio & Shiratsuka, Shigenori, 2004. "Policy commitment and expectation formation: Japan's experience under zero interest rates," The North American Journal of Economics and Finance, Elsevier, vol. 15(1), pages 75-100, March.
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  25. Shiller, Robert J, 1979. "The Volatility of Long-Term Interest Rates and Expectations Models of the Term Structure," Journal of Political Economy, University of Chicago Press, vol. 87(6), pages 1190-1219, December.
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