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Interest Rate Rules And Nominal Determinacy

  • BOYD III, J.H.
  • DOTSEY, M.

Monetary economists have recently begun a serious study of money supply rules that allow the Fed to adjustably peg the nominal interest rate under rational expectations. These rules vary from procedures that produce stationary nominal magnitudes to those that generate nonstationarities in nominal variables. Our paper investigates the determinacy properties of three representative interest rate rules. ; We use Blanchard and Kahn's solution technique as a starting point. It doesn't directly apply, so we first modify their procedure. We then narrow the range of solutions by considering the ARMA solutions of Evans and Honkapohja and the global minimum state variable solution of McCallum. We then examine these solutions in light of the expectational stability notions employed by DeCanio, Bray and Evans. ; Two of the three classes of rules yield a unique admissible solution. The exclusion of bubbles usually rules out the general ARMA solutions present in Evans and Honkapohja and leads to unique solutions via a saddlepoint property. Nonetheless, the nonstationary money supply rules we examine do not generally yield a well determined system over all parameter values. We employ the global minimum state variable methodology of McCallum and Evans' expectational stability in an effort to insure uniqueness. Although these methods are usually in agreement, one of the nonstationary rules yields a global minimum state variable solution that is expectationally unstable when the central bank is sensitive to interest rate deviations. Moreover, under these conditions, an alternative (non-global) minimum state variable solution is expectationally stable, casting doubt on the applicability of McCallum's global procedure in this context.

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Paper provided by University of Rochester - Center for Economic Research (RCER) in its series RCER Working Papers with number 222.

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Length: 24 pages
Date of creation: 1990
Date of revision:
Handle: RePEc:roc:rocher:222
Contact details of provider: Postal: University of Rochester, Center for Economic Research, Department of Economics, Harkness 231 Rochester, New York 14627 U.S.A.

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  1. Evans, George W., 1986. "Selection criteria for models with non-uniqueness," Journal of Monetary Economics, Elsevier, vol. 18(2), pages 147-157, September.
  2. Bennett T. McCallum, 1986. "Some Issues Concerning Interest Rate Pegging, Price Level Determinacy, and the Real Bills Doctrine," NBER Working Papers 1294, National Bureau of Economic Research, Inc.
  3. Frydman, Roman & Phelps, Edmund S., 1983. "Individual Expectations and Aggregate Outcomes: An Introduction to the Problem," Working Papers 83-02, C.V. Starr Center for Applied Economics, New York University.
  4. Evans, George, 1985. "Expectational Stability and the Multiple Equilibria Problem in Linear Rational Expectations Models," The Quarterly Journal of Economics, MIT Press, vol. 100(4), pages 1217-33, November.
  5. McCallum, Bennett T., 1983. "On non-uniqueness in rational expectations models : An attempt at perspective," Journal of Monetary Economics, Elsevier, vol. 11(2), pages 139-168.
  6. DeCanio, Stephen J, 1979. "Rational Expectations and Learning from Experience," The Quarterly Journal of Economics, MIT Press, vol. 93(1), pages 47-57, February.
  7. Blanchard, Olivier Jean & Kahn, Charles M, 1980. "The Solution of Linear Difference Models under Rational Expectations," Econometrica, Econometric Society, vol. 48(5), pages 1305-11, July.
  8. Dotsey, Michael & King, Robert G., 1983. "Monetary instruments and policy rules in a rational expectations environment," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 357-382, September.
  9. Marvin Goodfriend, 1987. "Interest rate smoothing and price level trend-stationarity," Working Paper 87-03, Federal Reserve Bank of Richmond.
  10. Evans, George & Honkapohja, Seppo, 1986. "A Complete Characterization of ARMA Solutions to Linear Rational Expectations Models," Review of Economic Studies, Wiley Blackwell, vol. 53(2), pages 227-39, April.
  11. Matthew B. Canzoneri & Dale W. Henderson & Kenneth S. Rogoff, 1981. "The information content of the interest rate and optimal monetary policy," International Finance Discussion Papers 192, Board of Governors of the Federal Reserve System (U.S.).
  12. Gourieroux, C & Laffont, J J & Monfort, Alain, 1982. "Rational Expectations in Dynamic Linear Models: Analysis of the Solutions," Econometrica, Econometric Society, vol. 50(2), pages 409-25, March.
  13. Bennett T. McCallum, 1982. "Price Level Determinacy with an Interest Rate Policy Rule and Rational Expectations," NBER Working Papers 0559, National Bureau of Economic Research, Inc.
  14. Blume, L. E. & Bray, M. M. & Easley, D., 1982. "Introduction to the stability of rational expectations equilibrium," Journal of Economic Theory, Elsevier, vol. 26(2), pages 313-317, April.
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