Price Level Determinacy under a Pure Interest Rate Peg

In this article we reexamine a famous result by T. J. Sargent and N. Wallace (1975, Journal of Political Economy 83, 241-254) according to which a "pure interest rate peg" leads to nominal price indeterminacy. We use P. Weil's (1991, International Economic Review 32, 37-53) generalization of the Sidrauski-Brock model, where arrival of new "generations" of infinitely lived agents is allowed, and we obtain the following results: (i) Nominal indeterminacy holds in the traditional Sidrauski Brock framework; (ii) This nominal indeterminacy disappears as soon as new generations arrive in time, via some rigorous version of Patinkin's "real balance effect"; (iii) A multiplicity of solutions may still remain, but full determinacy occurs in some cases, depending notably on fiscal policy or the distribution of endowments in time. (C) 2000 Academic Press