On the implementation of Markov-Perfect interest rate and money supply rules: global and local uniqueness

Michael Dotsey and Andreas Hornstein

No 09-06, Working Paper from Federal Reserve Bank of Richmond

Abstract: Currently there is a growing literature exploring the features of optimal monetary policy in New Keynesian models under both commitment and discretion. This literature usually solves for the optimal allocations that are consistent with a rational expectations market equiibrium, but it does not study how the policy can be implemented given the available policy instruments. Recently, however, King and Wolman (2004) have shown that a time-consistent policy cannot be implemented through the control of nominal money balances. In particular, they find that equilibria are not unique under a money stock regime. We find that their conclusion of non-uniqueness of Markov-perfect equilibria is sensitive to the instrument of choice. Surprisingly, if, instead, the monetary authority chooses the nominal interest rate, there exists a unique Markov-perfect equilibrium. We then investigate under what conditions a time-consistent planner can implement the optimal allocation by simply announcing his policy rule in a decentralized setting.

Keywords: Monetary policy; Interest rates (search for similar items in EconPapers)
Date: 2011
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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Working Paper: On the implementation of Markov-perfect interest rate and money supply rules: global and local uniqueness (2008)
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