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The optimality of nominal contracts

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  • Guido Tabellini

    (Universit Bocconi and Innocenzo Gasparini Institute for Economic Research, via Salasco 5, I-20136 Milano, ITALY)

  • Scott Freeman

    (Department of Economics, University of Texas, Austin, TX 78712, USA)

Abstract

This 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 Info

Article provided by Springer in its journal Economic Theory.

Volume (Year): 11 (1998)
Issue (Month): 3 ()
Pages: 545-562

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Handle: RePEc:spr:joecth:v:11:y:1998:i:3:p:545-562

Note: Received: March 29, 1996; revised version: February 25, 1997
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  1. White, Lawrence H, 1984. "Competitive Payments Systems and the Unit of Account," American Economic Review, American Economic Association, vol. 74(4), pages 699-712, September.
  2. Townsend, Robert M., 1987. "Asset-return anomalies in a monetary economy," Journal of Economic Theory, Elsevier, vol. 41(2), pages 219-247, April.
  3. Townsend, Robert M, 1989. "Currency and Credit in a Private Information Economy," Journal of Political Economy, University of Chicago Press, vol. 97(6), pages 1323-44, December.
  4. Smith, B.D., 1988. "A Model Of Nominal Contracts," RCER Working Papers 149, University of Rochester - Center for Economic Research (RCER).
  5. Lucas, Robert E, Jr, 1980. "Equilibrium in a Pure Currency Economy," Economic Inquiry, Western Economic Association International, vol. 18(2), pages 203-20, April.
  6. Azariadis, Costas & Cooper, Russell, 1985. "Predetermined Prices and the Allocation of Social Risks," The Quarterly Journal of Economics, MIT Press, vol. 100(2), pages 495-518, May.
  7. Fama, Eugene F., 1983. "Financial intermediation and price level control," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 7-28.
  8. Mitsui, Toshihide & Watanabe, Shinichi, 1989. "Monetary growth in a turnpike environment," Journal of Monetary Economics, Elsevier, vol. 24(1), pages 123-137, July.
  9. Svensson, Lars E O, 1985. "Money and Asset Prices in a Cash-in-Advance Economy," Journal of Political Economy, University of Chicago Press, vol. 93(5), pages 919-44, October.
  10. Gottfries, N., 1989. "A Model Of Nominal Contracts," Papers 455, Stockholm - International Economic Studies.
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Cited by:
  1. James T. E. Chapman & Antoine Martin, 2007. "Rediscounting Under Aggregate Risk with Moral Hazard," Working Papers 07-51, Bank of Canada.
  2. Michael Kremer & Paras Mehta, 2000. "Globalization and International Public Finance," NBER Working Papers 7575, National Bureau of Economic Research, Inc.
  3. Antoine Martin & Cyril Monnet, 2000. "When should labor contracts be nominal?," Working Papers 603, Federal Reserve Bank of Minneapolis.
  4. Scott Freeman, 2002. "Payments and Output," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 5(3), pages 602-617, July.

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