IDEAS home Printed from https://ideas.repec.org/p/red/sed012/255.html
   My bibliography  Save this paper

Runs on Interest Rate Pegs

Author

Listed:
  • Christopher Phelan

    (University of Minnesota)

  • Marco Bassetto

    (Federal Reserve Bank of Chicago)

Abstract

Until the last couple of years, most central banks around the world conducted monetary policy by setting targets for short-term interest rates. Manoeuvering interest rates as a way to achieve low and stable inflation is now regarded as a success story. Yet this was not always the case. As mentioned by Sargent (1983), the German Reichsbank also discounted treasury and commercial bills at fixed nominal interest rates in 1923; but, rather than contributing to stabilizing the value of the mark, the policy added fuel to the hyperinflation by transferring money to the government and to the lucky holders of the discounted commercial bills. In our paper, we study the extent to which setting a short-term interest rate can be used as a way of implementing a unique equilibrium in a monetary economy. We start our analysis in a simple environment where both the central bank and Treasury trade with all agents in the economy in every period. An explicit model of the interaction among the agents in the economy allows us to clearly specify the policies of the central bank and the fiscal authority as a mapping from histories to actions. We then analyze the consequences of an interest-rate rule, where the central bank sets a price at which private agents are free to trade currency for one-period debt. When the central bank faces a limit to its ability to print money, or when private agents are limited in the amount of bonds that can be pledged to the central bank in exchange for money, an interest-rate peg leads to multiple deterministic equilibria, one with low inflation and another one with high inflation and high money growth. The second equilibrium involves a run on the central bank's interest rate target, and the shadow interest rate in the private market is different from the central bank target. We then extend the analysis to environments where agents have infrequent access to financial markets, in which an interest rate run might evolve more gradually.

Suggested Citation

  • Christopher Phelan & Marco Bassetto, 2012. "Runs on Interest Rate Pegs," 2012 Meeting Papers 255, Society for Economic Dynamics.
  • Handle: RePEc:red:sed012:255
    as

    Download full text from publisher

    File URL: https://economicdynamics.org/meetpapers/2012/paper_255.pdf
    Download Restriction: no

    More about this item

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:red:sed012:255. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Christian Zimmermann). General contact details of provider: http://edirc.repec.org/data/sedddea.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.