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On the implementation of Markov-Perfect interest rate and money supply rules : global and local uniqueness

  • Michael Dotsey
  • Andreas Hornstein

Currently there is a growing literature exploring the features of optimal monetary policy in New Keynesian models under both commitment and discretion. This literature usually solves for the optimal allocations that are consistent with a rational expectations market equiibrium, but it does not study how the policy can be implemented given the available policy instruments. Recently, however, King and Wolman (2004) have shown that a time-consistent policy cannot be implemented through the control of nominal money balances. In particular, they find that equilibria are not unique under a money stock regime. We find that their conclusion of non-uniqueness of Markov-perfect equilibria is sensitive to the instrument of choice. Surprisingly, if, instead, the monetary authority chooses the nominal interest rate, there exists a unique Markov-perfect equilibrium. We then investigate under what conditions a time-consistent planner can implement the optimal allocation by simply announcing his policy rule in a decentralized setting.

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Paper provided by Federal Reserve Bank of Richmond in its series Working Paper with number 09-06.

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Date of creation: 2011
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Handle: RePEc:fip:fedrwp:09-06
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  1. R. King & A. Wolman, 2003. "Monetary discretion, pricing complementarity and dynamic multiple equilibria," Proceedings, Board of Governors of the Federal Reserve System (U.S.).
  2. Bernardino Ad�o & Isabel Correia & Pedro Teles, 2003. "Gaps and Triangles," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 699-713.
  3. John H. Boyd & Michael Dotsey, 1990. "Interest rate rules and nominal determinacy," Working Paper 90-01, Federal Reserve Bank of Richmond.
  4. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June.
  5. Bennett T. McCallum, 1981. "On Non-Uniqueness in Rational Expectations Models: An Attempt at Perspective," NBER Working Papers 0684, National Bureau of Economic Research, Inc.
  6. Andrew Atkeson & V. V. Chari & Patrick J. Kehoe, 2007. "On the optimal choice of a monetary policy instrument," Staff Report 394, Federal Reserve Bank of Minneapolis.
  7. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Interest-Rate Rules: I. General Theory," Levine's Bibliography 506439000000000384, UCLA Department of Economics.
  8. 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, vol. 83(2), pages 241-54, April.
  9. Carlstrom, Charles T. & Fuerst, Timothy S., 2001. "Timing and real indeterminacy in monetary models," Journal of Monetary Economics, Elsevier, vol. 47(2), pages 285-298, April.
  10. Bernardino Adao, 2000. "Gaps and Triangles," Econometric Society World Congress 2000 Contributed Papers 1904, Econometric Society.
  11. Charles T. Carlstrom & Timothy S. Fuerst, 1998. "Price-level and interest-rate targeting in a model with sticky prices," Working Paper 9819, Federal Reserve Bank of Cleveland.
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