Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/152917 
Year of Publication: 
2005
Series/Report no.: 
ECB Working Paper No. 483
Publisher: 
European Central Bank (ECB), Frankfurt a. M.
Abstract: 
In this paper, we analyze the relation between interest rate targets and money supply in a (bubble-free) rational expectations 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.
Subjects: 
contingent money supply
interest rate inertia
interest rate rules
macroeconomic stability
policy equivalence
JEL: 
E52
E41
E32
Document Type: 
Working Paper

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