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Endogenous uncertainty and the non-neutrality of money

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  • Maurizio Motolese

Abstract

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. Copyright Springer-Verlag Berlin Heidelberg 2003

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Bibliographic Info

Article provided by Springer in its journal Economic Theory.

Volume (Year): 21 (2003)
Issue (Month): 2 (03)
Pages: 317-345

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Handle: RePEc:spr:joecth:v:21:y:2003:i:2:p:317-345

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Related research

Keywords: Keywords and Phrases: Money non-neutrality; Monetary policy; Rational expectations; Rational beliefs; Rational belief equilibrium; Endogenous uncertainty; States of belief; Phillips curve.; JEL Classification Numbers: D5; D84; E52.;

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Cited by:
  1. Luigi Pierfranco Campiglio, 2012. "Market's SINS and the European Welfare State: theory and empirical evidences," DISCE - Quaderni dell'Istituto di Politica Economica ispe0060, Università Cattolica del Sacro Cuore, Dipartimenti e Istituti di Scienze Economiche (DISCE).
  2. Kurz, Mordecai, 2006. "Beauty contests under private information and diverse beliefs: how different?," MPRA Paper 233, University Library of Munich, Germany, revised Apr 2006.
  3. Raul Caruso & Friedrich Schneider, 2012. "Brutality of Jihadist Terrorism. A contest theory perspective and empirical evidence in the period 2002-2010," DISCE - Quaderni dell'Istituto di Politica Economica ispe0061, Università Cattolica del Sacro Cuore, Dipartimenti e Istituti di Scienze Economiche (DISCE).
  4. Carsten Nielsen, 2009. "Non-stationary, stable Markov processes on a continuous state space," Economic Theory, Springer, Springer, vol. 40(3), pages 473-496, September.
  5. Luigi Pierfranco Campiglio, 2013. "Why Italy's saving rate became (so) low?," DISCE - Quaderni dell'Istituto di Politica Economica ispe0063, Università Cattolica del Sacro Cuore, Dipartimenti e Istituti di Scienze Economiche (DISCE).
  6. Kurz, Mordecai & Motolese, Maurizio, 2006. "Risk Premia, diverse belief and beauty contests," MPRA Paper 247, University Library of Munich, Germany.
  7. Kurz, Mordecai, 2008. "Beauty contests under private information and diverse beliefs: How different?," Journal of Mathematical Economics, Elsevier, vol. 44(7-8), pages 762-784, July.
  8. Nielsen, Carsten Krabbe, 2008. "On rationally confident beliefs and rational overconfidence," Mathematical Social Sciences, Elsevier, vol. 55(3), pages 381-404, May.
  9. Mordecai Kurz & Maurizio Motolese, 2007. "Diverse Beliefs and Time Variability of Risk Premia," Discussion Papers, Stanford Institute for Economic Policy Research 06-044, Stanford Institute for Economic Policy Research.
  10. Mordecai Kurz, 2011. "Symposium: on the role of market belief in economic dynamics, an introduction," Economic Theory, Springer, Springer, vol. 47(2), pages 189-204, June.
  11. Ernst Fehr & Jean-Robert Tyran, 2004. "Expectations and the Effects of Money Illusion," DNB Staff Reports (discontinued) 115, Netherlands Central Bank.
  12. John S L McCombie & Marta Spreafico, 2013. "Can only democracies enhance “Human Development”? Evidence from the Former Soviet Countries," DISCE - Quaderni dell'Istituto di Politica Economica ispe0066, Università Cattolica del Sacro Cuore, Dipartimenti e Istituti di Scienze Economiche (DISCE).
  13. Kurz, Mordecai & Jin, Hehui & Motolese, Maurizio, 2003. "The role of expectations in economic fluctuations and the efficacy of monetary policy," CFS Working Paper Series 2003/42, Center for Financial Studies (CFS).
  14. William Branch & Bruce McGough, 2011. "Business cycle amplification with heterogeneous expectations," Economic Theory, Springer, Springer, vol. 47(2), pages 395-421, June.
  15. Mordecai Kurz, 2007. "Rational Diverse Beliefs and Economic Volatility," Discussion Papers, Stanford Institute for Economic Policy Research 06-045, Stanford Institute for Economic Policy Research.
  16. Kurz, Mordecai & Piccillo, Giulia & Wu, Howei, 2013. "Modeling diverse expectations in an aggregated New Keynesian Model," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 37(8), pages 1403-1433.

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