Research Discussion Papers, Bank of Finland
George W. Evans and Seppo Honkapohja
Friedman's money supply rule vs optimal interest rate policy
Abstract: Using New Keynesian models, we compare Friedmanís
k-percent money supply rule to optimal interest rate setting, with respect
to determinacy, stability under learning and optimality. We first 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 then show that Friedmanís rule also can
generate equilibria that are determinate and stable under learning.
However, in computing the mean quadratic welfare loss, we find that for
calibrated models Friedmanís rule performs poorly compared to the optimal
interest rate rule.
Keywords: monetary policy; determinacy; stability under learning; (follow links to similar papers)
JEL-Codes: E31; E52; (follow links to similar papers)
25 pages, April 14, 2003
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