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Federal Reserve Bank of Chicago
Working Paper Series
Monetary policy with state contingent interest rates
Bernardino Adão
Isabel Correia
Pedro Teles
Abstract

What instruments of monetary policy must be used in order to implement a unique equilibrium? This paper revisits the issues addressed by Sargent and Wallace (1975) on the multiplicity of equilibria when policy is conducted with interest rate rules. We show that the appropriate interest rate instruments under uncertainty are state- contingent interest rates, i.e. the nominal returns on state-contingent nominal assets. A policy that pegs state-contingent nominal interest rates, and sets the initial money supply, implements a unique equilibrium. These results hold whether prices are flexible or set in advance.


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Bernardino Adão & Isabel Correia & Pedro Teles, Monetary policy with state contingent interest rates, Federal Reserve Bank of Chicago, Working Paper Series WP-04-26, 2004.
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Keywords: Monetary policy ; Interest rates
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