Endogenous uncertainty and the non-neutrality of money |
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Authors: | Maurizio Motolese |
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Institution: | (1) Istituto di Politica Economica, Università Cattolica di Milano, via Necchi 5, 20123 Milano, ITALY (e-mail: maurizio.motolese@mi.unicatt.it) , IT |
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Abstract: | Summary. We study some implications of the Theory of Rational Beliefs to monetary policy. We show that monetary policy in a Rational
Beliefs environment can have an important effect on the characteristics of economic fluctuations. In Rational Beliefs Equilibria
money is generically non-neutral unlike Rational Expectations Equilibria in which money is neutral and monetary policy is
ineffective. Under Rational Beliefs Equilibria nominal prices and real output change not only in response to changes in the
exogenous growth rate of money but also in response to changes in the state of beliefs. In Rational Beliefs Equilibria monetary
shocks have real effects even when they are observed but are not fully anticipated. Furthermore, the non-neutrality of money
results in a short run Phillips curve. When money “flutters, real output sputters” 8]. We show that Endogenous Uncertainty and the distribution of market beliefs are the major explanatory variables of such fluctuations. Under Rational Expectations
monetary policy is ineffective because agents neutralize it by predicting correctly the effect of the policy. Under Rational
Beliefs it is shown instead that inflation and recessions can be substantially aggravated by the distribution of market beliefs.
Received: January 14, 2002; revised version: April 5, 2002
RID="*"
ID="*" I would like to thank Mordecai Kurz for his constant help and support. Most of the ideas developed hereby have been
inspired by innumerable and fruitful discussions with him. I have also greatly benefited from helpful comments by Stanley
Black, Luigi Campiglio, Carsten Nielsen and Ho-Mou Wu. I also received valuable remarks from participants at the V meeting
of “The Society for the Advancement of Economic Theory” held in Ischia, Italy, on July 2-8, 2001, where an initial draft of
the present work was presented. |
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Keywords: | and Phrases: Money non-neutrality Monetary policy Rational expectations Rational beliefs Rational belief equilibrium Endogenous uncertainty States of belief Phillips curve |
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