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Monetary Policy with State Contingent Interest Rates

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JEL Code 
E31 - Price Level; Inflation; Deflation
E40 - General
E52 - Monetary Policy (Targets, Instruments, and Effects)
E58 - Central Banks and Their Policies
E62 - Fiscal Policy; Public Expenditures, Investment, and Finance; Taxation
E63 - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization
What instruments of monetary policy must be used in order to implement a unique equilibrium? This paper revisits the issues addressed by Sargent and Wallace (1975) on the multiplicity of equilibria when policy isconducted with interest rate rules. We show that the appropriate interestrate instruments under uncertainty are state-contingent interest rates, i.e. the nominal returns on state-contingent nominal assets. A policy that pegs state-contingent nominal interest rates, and sets the initial money supply, implements a unique equilibrium. These results hold whether prices are flexible or set in advance.
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