Friedman's Money Supply Rule vs Optimal Interest Rate Policy

Evans, George W.; Honkapohja, Seppo

doi:10.2139/ssrn.438506

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Friedman's Money Supply Rule vs Optimal Interest Rate Policy

Bank of Finland Discussion Paper No. 10/2003

24 Pages Posted: 10 Oct 2003

See all articles by George W. Evans

George W. Evans

University of Oregon - Department of Economics; University of St. Andrews - School of Economics and Finance

Seppo Honkapohja

Centre for Economic Policy Research (CEPR); Aalto University School of Business; CESifo (Center for Economic Studies and Ifo Institute for Economic Research); Aalto University - School of Business

Date Written: April 14, 2003

Abstract

Using New Keynesian models, we compare Friedman's 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 Friedman's 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 Friedman's rule performs poorly compared to the optimal interest rate rule.

Keywords: Monetary policy, determinacy, stability under learning

JEL Classification: E52, E31

Suggested Citation: Suggested Citation

Evans, George W. and Honkapohja, Seppo and Honkapohja, Seppo, Friedman's Money Supply Rule vs Optimal Interest Rate Policy (April 14, 2003). Bank of Finland Discussion Paper No. 10/2003, Available at SSRN: https://ssrn.com/abstract=438506 or http://dx.doi.org/10.2139/ssrn.438506