"Rational" Expectations, the Optimal Monetary Instrument, and the Optimal Money Supply Rule

Abstract

Alternative monetary policies are analyzed in an ad hoc macroeconomic model in which the public's expectations about prices are rational. The ad hoc model is one in which there is long-run neutrality, since it incorporates the aggregate supply schedule proposed by Lucas. Following Poole, the paper studies whether pegging the interest rate or pegging the money supply period by period minimizes an ad hoc quadratic loss function. It turns out that the probility distribution of output--dispersion as well as mean--is independent of the particular deterministic money supply rule in effect, and that under an interest rate rule the price level is indeterminate.