Interest Rate Control and Nonconvergence to Rational Expectations

Peter Howitt

Journal of Political Economy, 1992, vol. 100, issue 4, 776-800

Abstract: Under general conditions, a monetary policy of pegging the nominal rate of interest will make it possible for any adaptive learning mechanism that satisfies a weak and plausible condition to converge to rational expectations. Instead, under such a policy an economy will undergo a cumulative process of the sort described.by Milton Friedman. This is shown in a micro-based finance constraint model as well as an IS-LM model. The same result applies also to more flexible policies of interest control and suggests a severe limitation to rational expectations analyses that ignore the issue of expectational stability. Copyright 1992 by University of Chicago Press.

Date: 1992
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