An Interest Rate Peg Might Be Better than You Think
15 Pages Posted: 21 Oct 2009 Last revised: 13 Nov 2009
Date Written: June 1, 2009
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: Suggested Citation