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Endogenous uncertainty and the non-neutrality of money

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Author Info
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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File URL: http://hdl.handle.net/10.1007/s00199-002-0293-8
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Publisher 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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  1. Kurz, Mordecai & Motolese, Maurizio, 2006. "Risk Premia, diverse belief and beauty contests," MPRA Paper 247, University Library of Munich, Germany. [Downloadable!]
  2. Carsten Nielsen, 2009. "Non-stationary, stable Markov processes on a continuous state space," Economic Theory, Springer, vol. 40(3), pages 473-496, September. [Downloadable!] (restricted)
  3. Mordecai Kurz (contact author) & Hehui Jin & Maurizio Motolese, 2003. "The Role of Expectations in Economic Fluctuations and the Efficacy of Monetary Policy," CFS Working Paper Series 2003/42, Center for Financial Studies. [Downloadable!]
  4. Ernst Fehr & Jean-Robert Tyran, . "Expectations and the Effects of Money Illusion," DNB Staff Reports (discontinued) 115, Netherlands Central Bank. [Downloadable!]
  5. Kurz, Mordecai, 2006. "Beauty contests under private information and diverse beliefs: how different?," MPRA Paper 233, University Library of Munich, Germany, revised Apr 2006. [Downloadable!]
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