Informational implications of interest rate rules
Returning to a topic first systematically treated by Poole (1970) in a textbook Keynesian model, this paper compares interest rate and money supply rules. Our analysis, by contrast, is conducted within a rational expectations macro model that incorporates flexible prices and informational frictions. With differential information, interest rate targets can affect the information content of market prices and real activity, but these real consequences can always be replicated by an appropriately chosen money stock rule with feedback to economic activity. However, when the policy authority has incomplete information about the state of the economic system, it faces a discrete choice between an interest rate peg and strict money stock control. Depending on the parameters of the model, either of these policies may be optimal, given the informational constraints faced by the monetary authority.
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