Abstract
A macro model of an inflationary economy incorporating the government budget constraint is set up to analyze two alternative monetary policy regimes: a passive policy and an active countercyclical policy. It is found that the policy is potentially unstable, especially when monetarist parameter values prevail, whereas the local stability of fullemployment equilibrium can always be ensured by choosing an appropriate countercyclical feedback rule for the monetary growth rate. An active monetary policy can also smooth out the business cycle in the neighborhood of equilibrium, but in accordance with Leijonhufvud's corridor hypothesis, instability may occur when output is pushed sufficiently far below its full-employment level.
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