Combination Monetary Policies to Stabilize Price and Output under Rational Expectations

Abstract

SARGENT AND WALLACE [ 1 1, 12] conclude that in a model with a Lucas-type supply curve and the assumption of rational expectations, there is no sense in which the [monetary] authority has the option to conduct countercyclical policy [12, p. 177]. Sargent and Wallace confine their analysis to pure money stock or interest rate policies. Woglom [14], drawing on the earlier work of Poole [10], LeRoy [5] and LeRoy and Waud [6], examines the effectiveness of combination policies within a model where expectations are formed rationally and with a Lucas-type supply schedule. Within the Poole or Woglom models a combination policy amounts to setting a deterministic relationship between the money stock and the interest rate. LeRoy, and LeRoy and Waud make clear that the ability to execute such combination policies depends on the current observability to the monetary authority of the interest rate and money stock (or level of reserves in the LeRoyWaud framework). Since the monetary authority's policy setting is conditioned on such current information, while in Woglom's framework private agents' expectations are conditioned only on past information, systematic policy actions (the parameters of the combination policy) will affect the distribution of real output. The Sargent-Wallace