Friedman's Money Supply Rule versus Optimal Interest Rate Policy
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Date
2003-07-12
Authors
Evans, George W., 1949-
Honkapohja, Seppo, 1951-
Journal Title
Journal ISSN
Volume Title
Publisher
University of Oregon, Dept of Economics
Abstract
Using New Keynesian models, we compare Friedman's k-percent money supply rule to optimal interest rate setting, with respect to determinacy, stability under learning and optimality. First we review the recent literature: open-loop interest rate rules are subject to indeterminacy and instability problems, but a properly chosen expectations-based rule yields determinacy and stability under learning, and implements optimal policy. We show that Friedman's rule also can generate equilibria that are determinate and stable under learning. However, computing the mean quadratic welfare loss, we find for calibrated models that Friedman's rule performs poorly when compared to the optimal interest rate rule.
Description
Keywords
Macroeconomics and monetary economics, Prices, business fluctuations, and cycles, Monetary policy, Central banking, and the supply of money and credit, Monetary policy (Targets, instruments, and effects), Price level, Inflation (Finance), Deflation (Finance)