| Abstract: | We examine interest rate rules in a model in which agents plan their consumption decisions in the face of two rigidities. First, households need cash balances to aid trade. Second, today's price level is inherited from past contracting decisions so that changes in nominal aggregate demand fall on output in the short run. Given these rigidities, the central bank can set the nominal interest rate in the short run. However, a pure interest rate peg fails to uniquely determine nominal and real magnitudes. A reaction function constraining the nominal interest rate to be continuous and showing some sensitivity to inflation does not exhibit this indeterminacy. |
