Using a Long-Term Interest Rate as the Monetary Policy Instrument
FRB of San Francisco Working Paper No. 2004-22
32 Pages Posted: 19 Jan 2005
Date Written: December 2004
Abstract
Using a short-term interest rate as the monetary policy instrument can be problematic near its zero bound constraint. An alternative strategy is to use a long-term interest rate as the policy instrument. We find when Taylor-type policy rules are used to set the long rate in a standard New Keynesian model, indeterminacy - that is, multiple rational expectations equilibria - may often result. However, a policy rule with a long rate policy instrument that responds in a forward-looking fashion to inflation expectations can avoid the problem of indeterminacy.
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