Interest Rate Rules Ensuring Strong Local Equilibrium Determinacy

Olivier Loisel

No 2004-03, Working Papers from Center for Research in Economics and Statistics

Abstract: In this paper we look for interest rate rules ensuring strong local equilibrium determinacy,i.e. making sure that there is a unique equilibrium starting out in the neighbourhood of thesteady state and that this equilibrium remains constantly in that neighbourhood. We showin a general framework that such interest rate rules exist and in the more specific frameworkof the canonical New Keynesian model that they are necessarily forward-looking, that is tosay that they make the nominal interest rate conditional on the private agents’ expectations.We also characterize the set of such interest rate rules implementing the optimal equilibriumunder discretion or under commitment (for a closed economy or a small open economy witha flexible exchange rate) or the fixed exchange rate equilibrium (for a small open economy)in this model.

Date: 2004
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