Bounded Interest Rate Feedback Rules in Continuous-Time

This paper analyses the dynamic consequences of interest rate feedback rules in a flexible-price model where money enters the utility function. Two alternative rules are considered based on past or predicted inflation rates. The main feature is to consider inflation rates that are selected over a bounded time horizon. We prove that if the Central Bank’s forecast horizon is not too long, an active and forward-looking monetary policy is not destabilizing: the equilibrium trajectory is unique and monotonic. This is an advantage with respect to active and backward-looking policies that are shown to lead to a unique but fluctuating dynamic.