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Money Stock Control with Reserve and Interest Rate Instruments Under Rational Expectations

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  • Bennett T. McCallum
  • James G. Hoehn

Abstract

This paper conducts a theoretical comparison of the potential effectiveness, in terms of money stock controllability, of interest rate and reserve instruments. Whereas previous studies have been basically static, the present analysis is carried out in the context of a dynamic macroeconomic model with rational expectations. Particular attention is paid to the distinction between contemporaneous and lagged reserve accounting (CRA and LRA). The criterion employed is the expectation of squared deviations of the (log of the) money stock from target values that are reset each period. Analysis in the basic model suggests the following substantive conclusions. (1) With a reserve instrument, monetary control will be more effective under CRA than LRA. (2) With a reserve instrument and LRA, control will be poorer than with an interest rate instrument. (3) For a wide range of parameter values, control will be better with a reserve instrument and CRA than with an interest rate instrument.

Suggested Citation

  • Bennett T. McCallum & James G. Hoehn, 1982. "Money Stock Control with Reserve and Interest Rate Instruments Under Rational Expectations," NBER Working Papers 0893, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:0893 Note: ME
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    References listed on IDEAS

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    1. Kaufman, Herbert M & Lombra, Raymond E, 1980. "The Demand for Excess Reserves, Liability Management, and the Money Supply Process," Economic Inquiry, Western Economic Association International, vol. 18(4), pages 555-566, October.
    2. Kareken, John H & Muench, Thomas & Wallace, Neil, 1973. "Optimal Open Market Strategy: The Use of Information Variables," American Economic Review, American Economic Association, vol. 63(1), pages 156-172, March.
    3. William Poole & Charles Lieberman, 1972. "Improving Monetary Control," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 3(2), pages 293-342.
    4. Charles Sivesind & Kevin Hurley, 1980. "Choosing an Operating Target for Monetary Policy," The Quarterly Journal of Economics, Oxford University Press, vol. 94(1), pages 199-203.
    5. Axilrod, Stephen H & Lindsey, David E, 1981. "Federal Reserve System Implementation of Monetary Policy: Analytical Foundations of the New Approach," American Economic Review, American Economic Association, vol. 71(2), pages 246-252, May.
    6. Mussa, Michael, 1981. "Sticky Prices and Disequilibrium Adjustment in a Rational Model of the Inflationary Process," American Economic Review, American Economic Association, vol. 71(5), pages 1020-1027, December.
    7. 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 241-254, April.
    8. Stephen F. LeRoy & David E. Lindsey, 1978. "Determining the monetary instrument: a diagrammatic exposition," Special Studies Papers 103, Board of Governors of the Federal Reserve System (U.S.).
    9. LeRoy, Stephen F & Lindsey, David E, 1978. "Determining the Monetary Instrument: A Diagrammatic Exposition," American Economic Review, American Economic Association, vol. 68(5), pages 929-934, December.
    10. William Poole, 1970. "Optimal Choice of Monetary Policy Instruments in a Simple Stochastic Macro Model," The Quarterly Journal of Economics, Oxford University Press, vol. 84(2), pages 197-216.
    11. Lucas, Robert E, Jr, 1973. "Some International Evidence on Output-Inflation Tradeoffs," American Economic Review, American Economic Association, vol. 63(3), pages 326-334, June.
    12. Albert E. Burger, 1972. "Money stock control," Review, Federal Reserve Bank of St. Louis, issue Oct, pages 10-18.
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    Cited by:

    1. Walsh, Carl E, 1984. "Interest Rate Volatility and Monetary Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 16(2), pages 133-150, May.

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