Working Paper: NBER ID: w0559
Authors: Bennett T. McCallum
Abstract: This paper reconsiders a result obtained by Sargent and Wallace, namely, that price level indeterminacy obtains in their well-known model if the monetary authorities adopt a policy feedback rule for the interest rate rather than the money stock. Since the Federal Reserve seems often to have used the federal funds rate as its operating instrument, with the money stack determined by the quantity demanded, this result suggests that the Sargent-Wallace model -- as well as others incorporating rational expectations -- is inconsistent with U.S. experience. It is here shown, however, that the indeterminacy result vanishes if the interest rate rule is chosen so as to have some desired effect on the expected quantity of money demanded. This revised conclusion holds even if considerable weight is given, in the choice of a rule, to the aim of smoothing interest rate fluctuations.
Keywords: No keywords provided
JEL Codes: No JEL codes provided
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Interest rate rule (E43) | expected money demand (E41) |
| expected money demand (E41) | price level (E30) |
| Interest rate rule (without regard to money demand) (E43) | price level indeterminacy (E30) |
| Interest rate rule (designed to impact money demand) (E43) | price level determinacy (E30) |