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Optimal monetary policy: distribution efficiency versus production efficiency

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  • Haitao Xiang

Abstract

This paper investigates the trade‐off between distribution effect and production effect of monetary policy when there exist unobservable idiosyncratic liquidity shocks. In the absence of risk‐sharing arrangements such as a credit market, monetary policy serves to provide ex post insurance to smooth consumption. Specifically, issuing interest‐bearing bonds restores credit transactions on money through bond‐money exchanges. Such a policy has a positive distribution effect, but the resulting inflation hampers production efficiency. It is demonstrated that the trade‐off between distribution efficiency gain and production efficiency loss would result in net welfare enhancement if consumers are relative‐risk‐averse enough. Politique monétaire optimale: efficacité dans la distribution versus efficacité dans la production. Ce mémoire examine la relation d'équivalence entre l'effet sur la distribution et l'effet sur la production de la politique monétaire quand existent des chocs de liquidité idiosyncratiques non‐observables. En l'absence d'arrangement pour le partage des risques, tel qu'un marché du crédit, la politique monétaire sert d'assurance ex post pour lisser les variations dans les niveaux de consommation. Spécifiquement, émettre des obligations qui paient des intérêts restore les transactions monétaires de crédit via les échanges obligations‐monnaie. Une telle politique a un effet positif sur la distribution mais l'inflation qui en résulte nuit à l'efficacité de la production. On montre que la relation d'équivalence entre les gains d'efficacité dans la distribution et la perte d'efficacité dans la production résultent en une amélioration du niveau net de bien‐être, si les consommateurs ont une aversion suffisamment grande au risque relatif.

Suggested Citation

  • Haitao Xiang, 2013. "Optimal monetary policy: distribution efficiency versus production efficiency," Canadian Journal of Economics/Revue canadienne d'économique, John Wiley & Sons, vol. 46(3), pages 836-864, August.
    • Handle: RePEc:wly:canjec:v:46:y:2013:i:3:p:836-864
    DOI: 10.1111/caje.12041
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    References listed on IDEAS

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