Money Supply and the Implementation of Interest Rate Targets

36 Pages Posted: 5 Aug 2005

See all articles by Andreas Schabert

Andreas Schabert

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

Multiple version iconThere are 2 versions of this paper

Date Written: June 2005

Abstract

In this paper, we analyze the relation between interest rate targets and money supply in a (bubble-free) rational expectation equilibrium of a standard cash-in-advance model. We examine contingent monetary injections 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 a money supply that leads 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

JEL Classification: E32, E41, E52

Suggested Citation

Schabert, Andreas, Money Supply and the Implementation of Interest Rate Targets (June 2005). CEPR Discussion Paper No. 5094. Available at SSRN: https://ssrn.com/abstract=777784

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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