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Optimal Stabilization Policy with Flexible Prices

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  • Aleksander Berentsen
  • Christopher Waller

Abstract

We construct a dynamic stochastic general equilibrium model to study optimal monetary stabilization policy. Prices are fully flexible and money is essential for trade. Our main result is that if the central bank pursues a long-run price path, thereby controlling inflation expectations, it can improve welfare by stabilizing short-run aggregate shocks. The optimal policy involves smoothing nominal interest rates which effectively smooths consumption across states. Failure to follow a long-run price path makes any stabilization attempt ineffective.

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File URL: http://www.cesifo-group.de/portal/page/portal/DocBase_Content/WP/WP-CESifo_Working_Papers/wp-cesifo-2005/wp-cesifo-2005-12/cesifo1_wp1638.pdf
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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 1638.

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Date of creation: 2005
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Handle: RePEc:ces:ceswps:_1638

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  1. Aleksander Berentsen & Guillaume Rocheteau & Shouyong Shi, 2002. "Friedman Meets Hosios: Efficiency in Search Models of Money," Working Papers, University of Toronto, Department of Economics shouyong-02-04, University of Toronto, Department of Economics.
  2. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, American Economic Association, vol. 37(4), pages 1661-1707, December.
  3. Berentsen, Aleksander & Camera, Gabriele & Waller, Christopher, 2007. "Money, credit and banking," Journal of Economic Theory, Elsevier, Elsevier, vol. 135(1), pages 171-195, July.
  4. Wallace, Neil, 2001. "Whither Monetary Economics?," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 42(4), pages 847-69, November.
  5. Aleksander Berentsen & Gabriele Camera & C hristopher W aller, 2005. "The Distribution Of Money Balances And The Nonneutrality Of Money," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 46(2), pages 465-487, 05.
  6. Randall Wright & Guillame Rocheteau, 2003. "Money in Search Equilibrium, in Competitive Equilibrium, and in Competitive Search Equilibrium," Levine's Bibliography 666156000000000302, UCLA Department of Economics.
  7. Ricardo Lagos & Randall Wright, 2002. "A unified framework for monetary theory and policy analysis," Working Paper, Federal Reserve Bank of Cleveland 0211, Federal Reserve Bank of Cleveland.
  8. Narayana R. Kocherlakota, 1996. "Money is memory," Staff Report, Federal Reserve Bank of Minneapolis 218, Federal Reserve Bank of Minneapolis.
  9. Ireland, Peter N, 1996. "The Role of Countercyclical Monetary Policy," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 104(4), pages 704-23, August.
  10. Lucas, Robert Jr., 1990. "Liquidity and interest rates," Journal of Economic Theory, Elsevier, Elsevier, vol. 50(2), pages 237-264, April.
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Cited by:
  1. Koessler, Frédéric & Forges, Françoise, 2008. "Long persuasion games," Economics Papers from University Paris Dauphine, Paris Dauphine University 123456789/179, Paris Dauphine University.
  2. Heijdra, Ben J. & Ligthart, Jenny E., 2010. "The Transitional Dynamics Of Fiscal Policy In Small Open Economies," Macroeconomic Dynamics, Cambridge University Press, Cambridge University Press, vol. 14(01), pages 1-28, February.
  3. Pietro Senesi & Alessandro Marchesiani, 2007. "Money and Nominal Bonds," 2007 Meeting Papers, Society for Economic Dynamics 835, Society for Economic Dynamics.
  4. José Suárez-Lledó, 2009. "Monetary Policy with Heterogeneous Collateralized Borrowing," Working Papers 374, Barcelona Graduate School of Economics.

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