Money growth rules as stabilization policies in open economies

Abstract

High degrees of relative risk aversion induces indeterminacy in cash-in-advance economies. In a small open economy context, this paper finds that endogenous money growth rules can pre-empt such sunspot equilibria in an open economy context. The most promising candidates are policies that actively target past inflation movements or aggregate demand as well as the expected price level.

Keywords:

• cash-in-advance economies
• Taylor rules
• sunspot equilibria

JEL Codes :

• E32
• E52

Acknowledgements

This paper was written while the author was a DFG Heisenberg Fellow. The author would also like to thank the referee and the editor for excellent comments and the Federal Reserve Bank of San Francisco for its hospitality.

Notes

Weder (2006a, b) consider Taylor rules to pre-empt sunspot expectations.

Of course, here I assume that money growth does not approach its lower bound, thus the (potential) effects of nonlinearities are not the subject of the present paper.

• Here I use the fact that equation (4) can rewritten as

  where L denotes the backshift operator.

I would like to thank the referee for suggesting this to me. Dittmar and Gavin (2005) analyze an interest rate rule that targets the price level in a closed economy.