Money Supply and the Implementation of Interest Rate Targets

Andreas Schabert

No 5094, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: In this paper, we analyze the relation between interest rate targets and money supply in a (bubble-free) rational expectation equilibrium of a standard cash-in-advance model. We examine contingent monetary injections 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 a money supply that leads 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.

Keywords: Interest rate rules; Contingent money supply; Macroeconomic stability; Policy equivalence; Interest rate inertia (search for similar items in EconPapers)
JEL-codes: E32 E41 E52 (search for similar items in EconPapers)
Date: 2005-06
New Economics Papers: this item is included in nep-cba, nep-fmk, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (13)

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Related works:
Working Paper: Money supply and the implementation of interest rate targets (2005)
Working Paper: Money Supply and the Implementation of Interest Rate Targets (2005)
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