Macroeconomic (in)stability under real interest rate targeting

Abstract

We show that in a one-sector monetary endogenous growth model under real interest rate targeting, the local stability properties of the economy`s balanced growth path depend crucially on the exact formulation of the cash-in-advance constraint and the degree of productive externalities. In particular, when a positive fraction (including 100%100%) of gross investment is subject to the liquidity constraint, the model exhibits indeterminacy and sunspots if and only if the equilibrium wage–hours locus is positively sloped and steeper than the labor supply curve. On the other hand, when real money balances are required only for the household`s consumption purchases, the economy always displays saddle-path stability and equilibrium uniqueness, regardless of the strength of productive externalities.