Working Paper: CEPR ID: DP3883
Authors: George W. Evans; Seppo Honkapohja
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. Computing the mean quadratic welfare loss, however, we find for calibrated models that Friedman?s rule performs poorly when compared to the optimal interest rate rule.
Keywords: determinacy; monetary policy; stability under learning
JEL Codes: E31; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Friedman's k-percent money supply rule (E51) | determinacy (D81) |
| Friedman's k-percent money supply rule (E51) | stability under learning (C62) |
| Friedman's k-percent money supply rule (E51) | welfare loss (D69) |
| optimal interest rate policy (E43) | welfare loss (D69) |
| Friedman's k-percent money supply rule (E51) | higher welfare losses than optimal interest rate policy (D69) |
| monetary policy (E52) | economic stability (E63) |
| monetary policy (E52) | welfare outcomes (I38) |