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On the Equivalence of Money Growth and Interest Rate Policy

  • Andreas Schabert

Central bank behavior is often summarized by simple rules for operat-ing targets, i.e., for a short-run nominal interest rate or for a money growth rate. In this paper we examine conditions under which these rules lead to identical fundamental solutions of a conventional business cycle model. When prices are flexible, forward looking interest rate rules can be equivalent to money growth policy. In particular, the consumption Euler equation implies that constant money growth is equivalent to a passive interest rate regime, while an active interest rate rule corresponds to an accommodating money growth policy. When prices are sticky, equivalence further requires either interest rate policy or households’ behavior to be history dependent. However, a central bank, which controls the money growth rate, cannot implement a sequence of nominal interest rates satisfying Taylor’s (1993) rule on a saddle stable equilibrium path.

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Paper provided by Business School - Economics, University of Glasgow in its series Working Papers with number 2003_6.

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Date of revision: Apr 2003
Handle: RePEc:gla:glaewp:2003_6
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