Money Supply and the Implementation of Interest Rate Targets

Andreas Schabert

No 05-059/2, Tinbergen Institute Discussion Papers from Tinbergen Institute

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 lump-sum injections of money 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 money injections that lead 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.

Keywords: Interest rate rules; contingent money supply; macroeconomic stability; policy equivalence; interest rate inertia (search for similar items in EconPapers)
JEL-codes: E32 E41 E52 (search for similar items in EconPapers)
Date: 2005-06-08
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (12)

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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:tin:wpaper:20050059

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