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Efficient Propagation of Shocks and the Optimal Return of Money

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  • Ricardo Cavalcanti
  • Andres Erosa

Abstract

We show that price stickiness is predicted by the theory of second best, applied to a random- matching model of money. The economy is hit with iid, aggregate, preference shocks, and allocations are allowed to be history dependent. Due to individual anonymity and lack of commitment, implementable allocations must satisfy participation constraints. Price stickiness becomes necessary for optimality, in terms of average, ex-ante welfare, when aggregate uncen- tainty is present but not too severe, and the degree of patience is neither too low or too high. By applying mechanism design to an alternative economy with centralized markets, we also Þnd important that macroeconomic policies, such as the taxation of money holdings, are unable to implement the Þrst best for price stckiness to have a social role

Suggested Citation

  • Ricardo Cavalcanti & Andres Erosa, 2006. "Efficient Propagation of Shocks and the Optimal Return of Money," 2006 Meeting Papers 738, Society for Economic Dynamics.
  • Handle: RePEc:red:sed006:738
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    References listed on IDEAS

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    1. Wallace, Neil, 1997. "Short-Run and Long-Run Effects of Changes in Money in a Random-Matching Model," Journal of Political Economy, University of Chicago Press, vol. 105(6), pages 1293-1307, December.
    2. Kiyotaki, Nobuhiro & Wright, Randall, 1989. "On Money as a Medium of Exchange," Journal of Political Economy, University of Chicago Press, vol. 97(4), pages 927-954, August.
    3. Kydland, Finn E. & Prescott, Edward C., 1980. "Dynamic optimal taxation, rational expectations and optimal control," Journal of Economic Dynamics and Control, Elsevier, vol. 2(1), pages 79-91, May.
    4. Ricardo Cavalcanti & Ed Nosal, 2009. "Some benefits of cyclical monetary policy," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 39(2), pages 195-216, May.
    5. Ricardo de O. Cavalcanti & Neil Wallace, 1999. "Inside and outside money as alternative media of exchange," Proceedings, Federal Reserve Bank of Cleveland, pages 443-468.
    6. Katzman, Brett & Kennan, John & Wallace, Neil, 2003. "Output and price level effects of monetary uncertainty in a matching model," Journal of Economic Theory, Elsevier, vol. 108(2), pages 217-255, February.
    7. Stephen E. Spear & Sanjay Srivastava, 1987. "On Repeated Moral Hazard with Discounting," Review of Economic Studies, Oxford University Press, vol. 54(4), pages 599-617.
    8. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
    9. Michael Woodford, 2003. "Optimal Interest-Rate Smoothing," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 861-886.
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    Citations

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    Cited by:

    1. Jonathan Chiu & Tsz-Nga Wong, 2015. "On the Essentiality of E-Money," Staff Working Papers 15-43, Bank of Canada.
    2. Hu, Tai-Wei & Rocheteau, Guillaume, 2013. "On the coexistence of money and higher-return assets and its social role," Journal of Economic Theory, Elsevier, vol. 148(6), pages 2520-2560.
    3. repec:eee:jetheo:v:172:y:2017:i:c:p:423-450 is not listed on IDEAS
    4. Rocheteau, Guillaume, 2012. "The cost of inflation: A mechanism design approach," Journal of Economic Theory, Elsevier, vol. 147(3), pages 1261-1279.
    5. Huangfu Stella, 2009. "Competitive Search Equilibrium with Private Information on Monetary Shocks," The B.E. Journal of Macroeconomics, De Gruyter, vol. 9(1), pages 1-27, March.
    6. Kocherlakota, Narayana & Wright, Randall, 2008. "Introduction to monetary and macro economics," Journal of Economic Theory, Elsevier, vol. 142(1), pages 1-4, September.
    7. Huang, Pidong & Igarashi, Yoske, 2011. "A comment on: 'Efficient propagation of shocks and the optimal return on money'," MPRA Paper 51206, University Library of Munich, Germany.

    More about this item

    Keywords

    Mechanism Design; monetary theory; history dependence;

    JEL classification:

    • E10 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - General
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General

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