Working Paper: CEPR ID: DP4126
Authors: Seppo Honkapohja; Kaushik Mitra
Abstract: Monetary policy is sometimes formulated in terms of a target level of inflation, a fixed time horizon and a constant interest rate that is anticipated to achieve the target at the specified horizon. These requirements lead to constant interest rate (CIR) instrument rules. Using the standard New Keynesian model, it is shown that some forms of CIR policy lead to both indeterminacy of equilibria and instability under adaptive learning. Some other forms of CIR policy perform better, however. We also examine the properties of the different policy rules in the presence of inertial demand and price behaviour.
Keywords: indeterminacy; inertia in demand; inflation inertia; inflation targeting; instability under learning
JEL Codes: E32; E52; E61
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| CIR policies (G22) | indeterminacy of equilibria (D59) |
| CIR policies (G22) | instability under adaptive learning (C62) |
| CIR policies (G22) | forward-looking behavior in the economy (D84) |
| forward-looking behavior in the economy (D84) | stability of rational expectations equilibria (C62) |