An Interest Rate Peg Might Be Better than You Think

15 Pages Posted: 21 Oct 2009 Last revised: 13 Nov 2009

See all articles by Markus Hörmann

Markus Hörmann

TU Dortmund University; Ruhr Graduate School in Economics

Andreas Schabert

University of Cologne - Department of Economics; University of Dortmund; University of Amsterdam - Faculty of Economics and Business

Date Written: June 1, 2009

Abstract

Active interest rate policy is frequently recommended based on its merits in reducing macroeconomic volatility and being a simple and transparent policy device. In a standard New Keynesian model,we show that an even simpler policy, namely an interest rate peg, can be welfare enhancing: The minimum state variable solution and an autoregessive solution under a peg can lead to lower welfare losses than the unique solution under an active interest rate rule. Given that a peg is usually blamed to facilitate endogenous fluctuations, we further show that a peg can be implemented in a way that ensures equilibrium determinacy.

Keywords: Interest rate rules, welfare losses, equilibrium determinacy, fundamental solutions

JEL Classification: E52, E51, E32

Suggested Citation

Hörmann, Markus and Schabert, Andreas, An Interest Rate Peg Might Be Better than You Think (June 1, 2009). Ruhr Economic Paper No. 115. Available at SSRN: https://ssrn.com/abstract=1492164 or http://dx.doi.org/10.2139/ssrn.1492164

Markus Hörmann

TU Dortmund University ( email )

D-44221 Dortmund, D-44221
Germany

Ruhr Graduate School in Economics ( email )

Hohenzollernstr. 1-3
Essen, NRW 45128
Germany

Andreas Schabert (Contact Author)

University of Cologne - Department of Economics ( email )

Cologne, 50923
Germany

University of Dortmund ( email )

Vogelpothsweg 87
Dortmund, 44227
Germany
+49 231 755 3288 (Phone)

University of Amsterdam - Faculty of Economics and Business ( email )

Roetersstraat 11
Amsterdam, 1018 WB
Netherlands

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