Finance and Economics Discussion Series (FEDS)
August 1998
Monetary Policy and Multiple Equilibria
Jess Benhabib, Stephanie Schmitt-Grohe, and Martin Uribe
Abstract:
In this paper, we study interest rate feedback rules whereby the nominal interest rate is set as an increasing function of the in ation rate and characterize conditions under which such rules generate multiple equilibria. We show that these conditions depend not only on the monetary-fiscal regime (as emphasized in the fiscal theory of the price level) but also on the way in which money is assumed to enter preferences and technology. We analyze this issue in exible and sticky price environments. We provide a number of examples in which, contrary to what is commonly believed, active monetary policy in combination with a fiscal policy that preserves government solvency gives rise to multiple equilibria and passive monetary policy renders the equilibrium unique.
Full paper (325 KB Postscript)Keywords: Interest rate feedback rules, multiple equilibria, sticky prices
PDF: Full Paper
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