Real Indeterminacy in Monetary Models with Nominal Interest Rate Distortions: The Problem with Inflation Targets

This paper demonstrates that in a standard monetary model there exists real indeterminacy whenever the nominal interest rate moves too closely with the real rate. A particular example of such a policy is if the central bank were to target the inflation rate. This is not a knife-edge result. The conclusion is robust to (1) a wide range of calibrations, (2) a more general monetary policy that targets a varying path for the inflation rate, and (3) a monetary environment that allows for endogenous velocity. The views stated herein are those of the authors and not necessarily those of the Federal Reserve Bank of Cleveland or those of the Board of Governors of the Federal Reserve System.