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The optimality of nominal contracts

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Author Info
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)

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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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Publisher 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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Find related papers by JEL classification:
E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Determination of Interest Rates; Term Structure of Interest Rates
E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
D91 - Microeconomics - - Intertemporal Choice and Growth - - - Intertemporal Consumer Choice; Life Cycle Models and Saving

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

  1. Mitsui, Toshihide & Watanabe, Shinichi, 1989. "Monetary growth in a turnpike environment," Journal of Monetary Economics, Elsevier, vol. 24(1), pages 123-137, July. [Downloadable!] (restricted)
  2. 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. [Downloadable!] (restricted)
  3. Gottfries, N., 1989. "A Model Of Nominal Contracts," Papers 455, Stockholm - International Economic Studies.
  4. Fama, Eugene F., 1983. "Financial intermediation and price level control," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 7-28. [Downloadable!] (restricted)
  5. 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. [Downloadable!] (restricted)
  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. [Downloadable!] (restricted)
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  7. Smith, B.D., 1988. "A Model Of Nominal Contracts," RCER Working Papers 149, University of Rochester - Center for Economic Research (RCER).
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  8. Lucas, Robert E, Jr, 1980. "Equilibrium in a Pure Currency Economy," Economic Inquiry, Oxford University Press, vol. 18(2), pages 203-20, April.
  9. 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. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. James T. E. Chapman & Antoine Martin, 2007. "Rediscounting under aggregate risk with moral hazard," Staff Reports 296, Federal Reserve Bank of New York. [Downloadable!]
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  2. Scott Freeman, 2002. "Payments and Output," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 5(3), pages 602-617, July. [Downloadable!] (restricted)
  3. Antoine Martin & Cyril Monnet, 2000. "When should labor contracts be nominal?," Working Papers 603, Federal Reserve Bank of Minneapolis. [Downloadable!]
    Other versions:
  4. Michael Kremer & Paras Mehta, 2000. "Globalization and International Public Finance," NBER Working Papers 7575, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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