Monetary policy with state contingent interest rates

What instruments of monetary policy must be used in order to implement a unique equilibrium? This paper revisits the issues addressed by Sargent and Wallace (1975) on the multiplicity of equilibria when policy is conducted with interest rate rules. We show that the appropriate interest rate instruments under uncertainty are state- contingent interest rates, i.e. the nominal returns on state-contingent nominal assets. A policy that pegs state-contingent nominal interest rates, and sets the initial money supply, implements a unique equilibrium. These results hold whether prices are flexible or set in advance.Monetary policy ; Interest rates

Monetary policy with single instrument feedback rules

We consider a standard cash in advance monetary model with flexible prices or prices set in advance and show that there are interest rate or money supply rules such that equilibria are unique. The existence of these single instrument rules depends on whether the economy has an infinite horizon or an arbitrarily large but finite horizon.Monetary policy ; Prices

Short and long interest rate targets

We show that short and long nominal interest rates are independent monetary policy instruments. The pegging of both helps solving the problem of multiplicity that arises when only short rates are used as the instrument of policy. A peg of the nominal returns on assets of different maturities is equivalent to a peg of state-contingent interest rates. These are the rates that should be targeted in order to implement unique equilibria. At the zero bound, while it is still possible to target state-contingent interest rates, that is no longer equivalent to the target of the term structure.

Gaps and triangles

In this paper, we derive principles of optimal cyclical monetary policy in an economy without capital, with a cash-in-advance restriction on household transactions, and with monopolistic firms that set prices one period in advance. The only distortionary policy instruments are the nominal interest rate and the money supply. In this environment, it is feasible to undo both the cash in advance and the price setting restrictions, but not the monopolistic competition distortion. We show that it is optimal to follow the Friedman rule, and thus offset the cash-in-advance restriction.Monetary policy

Monetary Policy with State Contingent Interest Rates

What instruments of monetary policy must be used in order to implement a unique equilibrium? This paper revisits the issues addressed by Sargent and Wallace (1975) on the multiplicity of equilibria when policy isconducted with interest rate rules. We show that the appropriate interestrate instruments under uncertainty are state-contingent interest rates, i.e. the nominal returns on state-contingent nominal assets. A policy that pegs state-contingent nominal interest rates, and sets the initial money supply, implements a unique equilibrium. These results hold whether prices are flexible or set in advance.

Monetary Policy with Single Instrument Feedback Rules

We consider a standard cash in advance monetary model with flexible prices or prices set in advance and show that there are interest rate or money supply rules such that equilibria are unique. The existence of these single instrument rules depends on whether the economy has an infinite horizon or an arbitrarily large but finite horizon.

The Monetary Transmission Mechanism: Is it Relevant for Policy?

We study environments with sticky prices, wages or portfolios where it is feasible and optimal to use monetary policy to replicate the allocation under full flexibility. In these environments the optimal policy does not depend on the scope of the frictions. In this sense, the strength of the monetary transmission mechanism is irrelevant for the conduct of monetary policy. So, asymmetries in the strength of the transmission mechanisms do not impose a cost on a common policy.

Unique equilibrium with single monetary instrument rules

We consider standard cash-in-advance monetary models and show that there are interest rate or money supply rules such that equilibria are unique. The existence of these single instrument rules depends on whether the economy has an infinite horizon or an arbitrarily large but finite horizon.

Gaps and Triangles

We derive principles of optimal short run monetary policy in a real business cycles model, with money and with monopolistic firms that set prices one period in advance. The only distortionary policy instruments are the nominal interest rates and the money supplies. In this environment it is feasible to undo both the cash in advance and the price setting restrictions. We show that the optimal allocation is achieved under the Friedman rule. We also show that, in general, it is not optimal to undo the restriction that prices are set one period in advance. Sticky prices provide the planner with tools to improve upon a distorted flexible prices allocation.

Short and Long Interest Rate Targets

We show that short and long nominal interest rates are independent monetary policy instruments. The pegging of both helps solving the problem of multiplicity that arises when only short rates are used as the instrument of policy. A peg of the nominal returns on assets of different maturities is equivalent to a peg of state-contingent interest rates. These are the rates that should be targeted in order to implement unique equilibria. At the zero bound, while it is still possible to target state-contingent interest rates, that is no longer equivalent to the target of the term structure.