TAILIEUCHUNG - Limits on Interest Rate Rules in the ISModel

The interest-on-reserves regime has four attractive features. First, the regime would make full use of two monetary policy instruments—open market operations and interest on reserves—to enable a central bank to simultaneously pursue interest rate policy and an independent objective for aggregate bank reserves. That would potentially improve on the Fed’s current operating procedures that obligate bank reserves to support interest rate policy. Bank reserves could be varied to offset shocks to the private supply of broad liquidity in financial markets in the interest-on-reserves regime, while interest rate policy could be used to stabilize the overall macroeconomy. Second, the interest-on-reserves regime. | Limits on Interest Rate Rules in the IS Model William Kerr and Robert G. King Many central banks have long used a short-term nominal interest rate as the main instrument through which monetary policy actions are implemented. Some monetary authorities have even viewed their main job as managing nominal interest rates by using an interest rate rule for monetary policy. It is therefore important to understand the consequences of such monetary policies for the behavior of aggregate economic activity. Over the past several decades accordingly there has been a substantial amount of research on interest rate rules. 1 This literature finds that the feasibility and desirability of interest rate rules depends on the structure of the model used to approximate macroeconomic reality. In the standard textbook Keynesian macroeconomic model there are few limits almost any interest rate Kerr is a recent graduate of the University of Virginia with bachelor s degrees in system engineering and economics. King is A. W. Robertson Professor of Economics at the University of Virginia consultant to the research department of the Federal Reserve Bank of Richmond and a research associate of the National Bureau of Economic Research. The authors have received substantial help on this article from Justin Fang of the University of Pennsylvania. The specific expectational IS schedule used in this article was suggested by Bennett McCallum 1995 . We thank Ben Bernanke Michael Dotsey Marvin Goodfriend Thomas Humphrey Jeffrey Lacker Eric Leeper Bennett McCallum Michael Woodford and seminar participants at the Federal Reserve Banks of Philadelphia and Richmond for helpful comments. The views expressed are those of the authors and do not necessarily reflect those of the Federal Reserve Bank of Richmond or the Federal Reserve System. 1 This literature is voluminous but may be usefully divided into four main groups. First there is work with small analytical models with an IS-LM structure including .

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