Limits on Interest Rate Rules in the IS Model

Federal Reserve Bank of Richmond Economic Quarterly, Vol. 82, No. 2, pp. 47-75, 1996

Posted: 20 Aug 2008

See all articles by William Kerr

William Kerr

Harvard University - Entrepreneurial Management Unit

Robert G. King

Boston University - Department of Economics; Federal Reserve Bank of Richmond - Research Department; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: 1996

Abstract

There has been a substantial amount of research on interest rate rules. This literature finds that the feasibility and desirability of interest rate rules depends on the structure of the model used to approximate macroeconomic reality. We employ a series of macroeconomic models to shed light on how aspects of model structure influence the limits on interest rate rules. In particular, we show that a simple respecification of the IS schedule, which we call the expectational IS schedule, makes the textbook model generate the same limits on interest rate rules as the fully articulated models. We then use this simple model to study the design of interest rate rules with nominal anchors. If the monetary authority adjusts the interest rate in response to deviations of the price level from a target path, then there is a unique equilibrium under a wide range of parameter choices: all that is required is that the authority raise the nominal rate when the price level is above the target path and lower it when the price level is below the target path. By contrast, if the monetary authority responds to deviations of the inflation rate from a target path, then a much more aggressive pattern is needed: the monetary authority must make the nominal rate rise by more than one-for-one with the inflation rate. Our results on interest rate rules with nominal anchors are preserved when we further extend the model to include the influence of expectations on aggregate supply.

Keywords: interest rate rules, monetary policy, IS-LM, inflation targets, prices

JEL Classification: E4, E5, E6

Suggested Citation

Kerr, William R. and King, Robert G., Limits on Interest Rate Rules in the IS Model (1996). Federal Reserve Bank of Richmond Economic Quarterly, Vol. 82, No. 2, pp. 47-75, 1996. Available at SSRN: https://ssrn.com/abstract=1230144

William R. Kerr (Contact Author)

Harvard University - Entrepreneurial Management Unit ( email )

Soldiers Field Road
Morgan 270C
Boston, MA 02163
United States

Robert G. King

Boston University - Department of Economics ( email )

270 Bay State Road
Boston, MA 02215
United States
617-353-5941 (Phone)

Federal Reserve Bank of Richmond - Research Department

P.O. Box 27622
Richmond, VA 23261
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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