Implications of endogenous money supply rules in dynamic models with perfect foresight

Abstract

This paper examines perfect-foresight optimizing models with endogenous money supply rules in order to elucidate the role of money supply policies in considering the stability issue in dynamic models with perfect foresight. We first assume that the monetary expansion rate depends on the rate of inflation, and show that a continuum of converging equilibria easily emerges under this policy regime in both short-run and long-run dynamic models. We also discuss the case where money supply changes with government budget deficits under fixed fiscal actions. In each case, we try to explain intuitively how and why endogenous money supply rules may yield multiple stable solutions. Our analysis reveals that expectations formation plays a crucial role for implications of endogenous money supply rules.