Wicksell's monetary framework and dynamic stability

Traditionally, central banks seeking to stabilize general prices have followed policies similar to those advocated by Knut Wicksell: when prices are higher that desired, raise interest rates to exert downward pressure on prices, and conversely. Despite the historical predominance of interest rate-based monetary policies, analysts frequently focus on how prices are affected by control of the money stock (or its high-powered base). In those cases where they do examine the relationship between interest rates and prices, they mostly do so in a Keynesian framework rather than a Wicksellian one. For several reasons, Wicksell's analysis deserves renewed attention. Here, we examine whether his interest rate-adjustment rule, coupled with his famous cumulative process mechanism of price level change, can stabilize prices (and interest rates). We find that if the interest rate rule is properly specified, it can.