Money supply and the implementation of interest rate targets

Andreas Schabert

No 483, Working Paper Series from European Central Bank

Abstract: In this paper, we analyze the relation between interest rate targets and money supply in a (bubble-free) rational expectations 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. JEL Classification: E52, E41, E32

Keywords: contingent money supply; interest rate inertia; interest rate rules; macroeconomic stability; policy equivalence (search for similar items in EconPapers)
Date: 2005-05
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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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Persistent link: https://EconPapers.repec.org/RePEc:ecb:ecbwps:2005483

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