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The optimality of nominal contracts

  • Scott Freeman
  • Guido Tabellini

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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File URL: http://dallasfed.org/assets/documents/research/papers/1991/wp9114.pdf
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Paper provided by Federal Reserve Bank of Dallas in its series Research Paper with number 9114.

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Date of creation: 1991
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Handle: RePEc:fip:feddrp:9114
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  1. Townsend, Robert M., 1987. "Asset-return anomalies in a monetary economy," Journal of Economic Theory, Elsevier, vol. 41(2), pages 219-247, April.
  2. Smith, B.D., 1988. "A Model Of Nominal Contracts," RCER Working Papers 149, University of Rochester - Center for Economic Research (RCER).
  3. Mitsui, Toshihide & Watanabe, Shinichi, 1989. "Monetary growth in a turnpike environment," Journal of Monetary Economics, Elsevier, vol. 24(1), pages 123-137, July.
  4. 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.
  5. Gottfries, N., 1989. "A Model Of Nominal Contracts," Papers 455, Stockholm - International Economic Studies.
  6. Costas Azariadis & Russell Cooper, 1983. "Predetermined Prices and the Allocation of Social Risks," Cowles Foundation Discussion Papers 660, Cowles Foundation for Research in Economics, Yale University.
  7. 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.
  8. 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.
  9. Lucas, Robert E, Jr, 1980. "Equilibrium in a Pure Currency Economy," Economic Inquiry, Western Economic Association International, vol. 18(2), pages 203-20, April.
  10. Fama, Eugene F., 1983. "Financial intermediation and price level control," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 7-28.
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