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Friedman’s money supply rule vs optimal interest rate policy

  • George W. Evans

    (Faculty of Economics & ´Politics, University of Cambridge)

  • Seppo Honkapohja

    (Faculty of Economics & ´Politics, University of Cambridge)

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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Paper provided by EconWPA in its series Macroeconomics with number 0405002.

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Date of creation: 03 May 2004
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Handle: RePEc:wpa:wuwpma:0405002
Note: Type of Document - pdf
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  1. James Bullard & Kaushik Mitra, . "Determinacy, Learnability, and Monetary Policy Inertia," Discussion Papers 00/43, Department of Economics, University of York.
  2. Svensson, Lars E.O., 1998. "Inflation Targeting as a Monetary Policy Rule," Seminar Papers 646, Stockholm University, Institute for International Economic Studies.
  3. 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.
  4. Ben S. Bernanke & Michael Woodford, 1997. "Inflation Forecasts and Monetary Policy," NBER Working Papers 6157, National Bureau of Economic Research, Inc.
  5. 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.
  6. Kaushik Mitra & James Bullard, . "Learning About Monetary Policy Rules," Discussion Papers 00/41, Department of Economics, University of York.
  7. Richard Clarida & Jordi Gali & Mark Gertler, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," NBER Working Papers 7147, National Bureau of Economic Research, Inc.
  8. Evans, G W & Honkapohja, Seppo, 2002. "Policy Interaction, Learning and the Fiscal Theory of Prices," CEPR Discussion Papers 3564, C.E.P.R. Discussion Papers.
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