Indeterminacy and interest rate rules: The role of fiscal policy

The present paper analyses the stabilizing or destabilizing effects that are associated with monetary policy rules. Based on simulations of calibrated dynamical models with cash-in-advance constraints it is shown, that the specific assumptions made regarding the government sector and particularly the assumptions made about fiscal policy are important in order to assess such stabilizing or destabilizing effects. Existing analyses are extended in two respects. First, the paper considers distortionary taxation. Second, it is assumed that the government’s deficit must obey specific rules regarding the deficit ratio. As a consequence we arrive at different conclusions regarding the possibly destabilizing effect of simple Taylor-like interest rate rules than earlier studies