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Finance and Economics Discussion Series
The Finance and Economics Discussion Series logo links to FEDS home page Monetary Policy and Multiple Equilibria
Jess Benhabib, Stephanie Schmitt-Grohe, and Martin Uribe

Abstract: In this paper, we characterize conditions under which interest rate feedback rules whereby the nominal interest rate is set as an increasing function of the inflation rate generate multiple equilibria. We show that these conditions depend not only on the 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 flexible 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.

Keywords: Interest rate feedback rules, multiple equilibria, sticky prices

Full paper (336 KB PDF) | Full paper (325 KB Postscript)

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Last update: August 3, 1998