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Monetary Policy and Multiple Equilibria

  • Jess Benhabib


    (New York University)

  • Stephanie Schmitt-Grohe


    (Rutgers University)

  • Martin Uribe


    (University of Pennsylvania)

In this paper, we characterize conditions under which interest rate feedback rules that set the nominal interest rate as an increasing function of the inflation rate induce aggregate instability by generating multiple equilibria. We show that these conditions depend not only on the monetary-fiscal regime (as emphasized in the fiscal theory of the price level) but also on the way in which money is assumed to enter preferences and technology. We provide a number of examples in which, contrary to what is commonly believed, active monetary policy in combination with a fiscal policy that preserves government solvency under all circumstances gives rise to multiple equilibria, and passive monetary policy renders the equilibrium unique. Our general conclusion holds in flexible- and sticky-price environments as well as under backward- or forward-looking interest rate feedback rules.

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Paper provided by Rutgers University, Department of Economics in its series Departmental Working Papers with number 199914.

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Date of creation: 23 Sep 1999
Date of revision:
Handle: RePEc:rut:rutres:199914
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  8. Mulligan, Casey B, 1997. "Scale Economies, the Value of Time, and the Demand for Money: Longitudinal Evidence from Firms," Journal of Political Economy, University of Chicago Press, vol. 105(5), pages 1061-79, October.
  9. Benhabib, J. & Schmitt-Grohe, S. & Uribe, M., 1999. "Avoiding Liquidity Traps," Working Papers 99-21, C.V. Starr Center for Applied Economics, New York University.
  10. Woodford, Michael, 1997. "Doing Without Money: Controlling Inflation in a Post-Monetary World," Seminar Papers 632, Stockholm University, Institute for International Economic Studies.
  11. Schmitt-Grohe, Stephanie & Uribe, Martin, 2000. "Price level determinacy and monetary policy under a balanced-budget requirement," Journal of Monetary Economics, Elsevier, vol. 45(1), pages 211-246, February.
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  23. Julio J. Rotemberg & Michael Woodford, 1999. "Interest Rate Rules in an Estimated Sticky Price Model," NBER Chapters, in: Monetary Policy Rules, pages 57-126 National Bureau of Economic Research, Inc.
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  27. William Poole, 1999. "Monetary policy rules?," Review, Federal Reserve Bank of St. Louis, issue Mar, pages 3-12.
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