Freidman's Money Supply Rule versus Optimal Interest Rate Policy

Seppo Honkapohja and George Evans

No 3883, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: 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. First we 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 show that Friedman?s rule also can generate equilibria that are determinate and stable under learning. Computing the mean quadratic welfare loss, however, we find for calibrated models that Friedman?s rule performs poorly when compared to the optimal interest rate rule.

Keywords: Monetary policy; Determinacy; Stability under learning (search for similar items in EconPapers)
JEL-codes: E31 E52 (search for similar items in EconPapers)
Date: 2003-05
New Economics Papers: this item is included in nep-mac and nep-mon
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Citations: View citations in EconPapers (18)

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