Real Indeterminacy in Monetary Models with Nominal Interest Rate Distortions: The Problem with Inflation Targets

Abstract

This paper demonstrates that in a standard monetary model there exists real indeterminacy whenever the nominal interest rate moves too closely with the real rate. A particular example of such a policy is if the central bank were to target the inflation rate. This is not a knife-edge result. The conclusion is robust to (1) a wide range of calibrations, (2) a more general monetary policy that targets a varying path for the inflation rate, and (3) a monetary environment that allows for endogenous velocity.

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