NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

On the Optimality of Interest Rate Smoothing

Sergio Rebelo, Danyang Xie

NBER Working Paper No. 5947
Issued in February 1997
NBER Program(s):   EFG   ME

This paper studies some continuous-time cash-in-advance models in which interest rate smoothing is optimal. We consider both deterministic and stochastic models. In the stochastic case we obtain two results of independent interest: (i) we study what is, to our knowledge, the only version of the neoclassical model under uncertainty that can be solved in closed form in continuous time; and (ii) we show how to characterize the competitive equilibrium of a stochastic continuous time model that cannot be computed by solving a planning problem. We also discuss the scope for monetary policy to improve welfare in an economy with a suboptimal real competitive equilibrium, focusing on the particular example of an economy with externalities.

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Published: Journal of Monetary Economics, Vol. 43, no. 2 (April 1999): 263-282.

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