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Friedman's money supply rule vs optimal interest rate policy

  • Evans, George W.

    (University of Oregon)

  • Honkapohja, Seppo

    (University of Helsinki)

Using New Keynesian models, we compare Friedman’s k-percent money supply rule to optimal interest rate setting, with respect to determinacy, stability under learning and optimality. We first review the recent literature. Open-loop interest rate rules are subject to indeterminacy and instability problems, but a properly chosen expectations-based rule yields determinacy and stability under learning, and implements optimal policy. We then show that Friedman’s rule also can generate equilibria that are determinate and stable under learning. However, in computing the mean quadratic welfare loss, we find that for calibrated models Friedman’s rule performs poorly compared to the optimal interest rate rule.

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File URL: http://www.suomenpankki.fi/en/julkaisut/tutkimukset/keskustelualoitteet/Documents/0310.pdf
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Paper provided by Bank of Finland in its series Research Discussion Papers with number 10/2003.

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Length: 25 pages
Date of creation: 14 Apr 2003
Date of revision:
Handle: RePEc:hhs:bofrdp:2003_010
Contact details of provider: Postal: Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland
Web page: http://www.suomenpankki.fi/en/

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  1. Howitt, Peter, 1992. "Interest Rate Control and Nonconvergence to Rational Expectations," Journal of Political Economy, University of Chicago Press, vol. 100(4), pages 776-800, August.
  2. George W. Evans & Seppo Honkapohja, 2002. "Policy Interaction, Learning and the Fiscal Theory of Prices," University of Oregon Economics Department Working Papers 2002-17, University of Oregon Economics Department, revised 07 Jun 2007.
  3. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
  4. Bullard, James & Mitra, Kaushik, 2002. "Learning about monetary policy rules," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1105-1129, September.
  5. Bernanke, Ben S & Woodford, Michael, 1997. "Inflation Forecasts and Monetary Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(4), pages 653-84, November.
  6. Lars E.O. Svensson, 1998. "Inflation Targeting as a Monetary Policy Rule," NBER Working Papers 6790, National Bureau of Economic Research, Inc.
  7. James Bullard & Kaushik Mitra, . "Determinacy, Learnability, and Monetary Policy Inertia," Discussion Papers 00/43, Department of Economics, University of York.
  8. Michael Woodford, 1999. "Commentary : how should monetary policy be conducted in an era of price stability?," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 277-316.
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