Template-Type: ReDIF-Paper 1.0
Series: Tinbergen Institute Discussion Papers
Creation-Date: 2005-06-08
Number: 05-059/2
Author-Name: Andreas Schabert
Author-Email: a.schabert@uva.nl
Author-Workplace-Name: Faculty of Economics and Econometrics, Universiteit van Amsterdam
Title: Money Supply and the Implementation of Interest Rate Targets
Abstract: In this paper, we analyze the relation between interest rate targets and money supply in a (bubble-free) rational expectations equilibrium of a standard cash-in-advance model. We examine lump-sum injections of money aimed to implement interest rate sequences that satisfy interest rate target rules. An interest rate target with a positive inflation feedback in general corresponds to money growth rates rising with inflation. When prices are not completely flexible, this implies that a non-destabilizing money supply cannot implement a forward-looking and active interest rate rule. This principle also applies for an alternative model version with an interest elastic money demand. The implementation of a Taylor-rule then requires money injections that lead to explosive or oscillatory equilibrium sequences. In contrast, an inertial interest rate target can be implemented by a non-destabilizing money supply, even if the inflation feedback exceeds one, which is often found in interest rate rule regressions.
Classification-JEL: E52; E41; E32
Keywords: Interest rate rules; contingent money supply; macroeconomic stability; policy equivalence; interest rate inertia
File-Url: https://papers.tinbergen.nl/05059.pdf
File-Format: application/pdf
File-Size: 562018 bytes
Handle: RePEc:tin:wpaper:20050059