Limits on Interest Rate Rules in the IS Model

M any central banks have long used a short-term nominal interest rate as the main instrument through which monetary policy actions are implemented. Some monetary authorities have even viewed their main job as managing nominal interest rates, by using an interest rate rule for monetary policy. It is therefore important to understand the consequences of such monetary policies for the behavior of aggregate economic activity. Over the past several decades, accordingly, there has been a substantial amount of research on interest rate rules.1 This literature finds that the feasibility and desirability of interest rate rules depends on the structure of the model used to approximate macroeconomic reality. In the standard textbook Keynesian macroeconomic model, there are few limits: almost any interest rate