Monetary Policy with State Contingent Interest Rates
Bernardino Adão, Isabel Correia, Pedro Teles
What instruments of monetary policy must be used in order to imple- ment a unique equilibrium? This paper revisits the issues addressed by Sargent and Wallace (1975) on the multiplicity of equilibria when policy is conducted with interest rate rules. We show that the appropriate interest rate instruments under uncertainty are state-contingent interest rates, i.e. the nominal returns on state-contingent nominal assets. A policy that pegs state-contingent nominal interest rates, and sets the initial money supply, implements a unique equilibrium. These results hold whether prices are .exible or set in advance.
