Using a Long-Term Interest Rate as the Monetary Policy Instrument

Using a short-term interest rate as the monetary policy instrument can be problematic near its zero bound constraint. An alternative strategy is to use a long-term interest rate as the policy instrument. We find, when Taylor type policy rules are used to set the long rate in a standard New Keynesian model, indeterminacy–that is, multiple rational expectations equilibria–may often result. However, a policy rule with a long rate policy instrument that responds in a "forward-looking" fashion to inflation expectations can avoid the problem of indeterminacy.