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Real Balance Effects, Determinacy and Optimal Monetary Policy

Piergallini, Alessandro (2004): Real Balance Effects, Determinacy and Optimal Monetary Policy.

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Abstract

This paper presents a dynamic New Keynesian macroeconomic model with real balance effects. Both the conditions of equilibrium determinacy under an interest rate rule of the Taylor-type and the implications for optimal monetary policy are considered. We find a number of results that would not appear in the traditional framework. It is shown that the real balance effect makes the so-called "Taylor principle" not necessary for determinacy of rational expectations equilibrium. A relatively "passive" monetary policy is found to be feasible also in the long run, but not necessarily optimal. In particular, within a class of policy rules constrained to be a linear function of state variables, an "active" optimal interest rate rule is more likely to be verified under commitment rather than under discretion.

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