The optimality of nominal contracts
AbstractThis paper presents a model in which agents choose to use money as a medium of exchange, a means of payment, and a unit of account. The paper defines conditions under which nominal contracts, promising future payment of a fixed number of units of fiat money, prove to be the optimal contract form in the presence of either relative or aggregate price risk. When relative prices are random, nominal contracts are optimal if individuals have ex ante similar preferences over future consumption. When the aggregate price level is random, whether from shocks to the money supply or aggregate output, nominal contracts (perhaps coupled with equity contracts) lead to optimal risk-sharing if individuals have the same degree of relative risk aversion. Finally, nominal contracts may be optimal if the repayment of contracts is subject to a binding cash-in-advance constraint. In this case, a contingent contract increases the risk of holding excessive cash balances.
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Bibliographic InfoArticle provided by Springer in its journal Economic Theory.
Volume (Year): 11 (1998)
Issue (Month): 3 ()
Note: Received: March 29, 1996; revised version: February 25, 1997
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Other versions of this item:
- E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
- E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
- D91 - Microeconomics - - Intertemporal Choice - - - Intertemporal Household Choice; Life Cycle Models and Saving
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