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The Value of Interest Rate Stabilization Policies When Agents Are Learning

John Duffy and Wei Xiao

Journal of Money, Credit and Banking, 2007, vol. 39, issue 8, 2041-2056

Abstract: We examine the expectational stability (E-stability) of rational expectations equilibrium in the "New Keynesian" model where monetary policy is optimally derived and interest rate stabilization is added to the central bank's traditional objectives of inflation and output stabilization. We consider both the case where the central bank lacks a commitment technology and the case of full commitment. We show that for both cases, optimal policy rules yield rational expectations equilibria that are E-stable for a wide range of empirically plausible parameter values. These findings stand in contrast to Evans and Honkapohja's findings for optimal monetary policy rules in environments where interest rate stabilization is not a central bank objective. Copyright 2007 The Ohio State University.

Date: 2007
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