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Inflationary Bias in a Simple Stochastic Economy

Author

Listed:
  • Ioannis Karatzas
  • Martin Shubik
  • William D. Sudderth
  • John Geanakoplos

Abstract

We construct explicit equilibria for strategic market games used to model an economy with fiat money, one nondurable commodity, countably many time- periods, and a continuum of agents. The total production of the commodity is a random variable that fluctuates from period to period. In each period, the agents receive equal endowments of the commodity, and sell them for cash in a market; their spending determines, endogenously, the price of the commodity. All agents have a common utility function, and seek to maximize their expected total discounted utility from consumption. One result concerns models with an outside bank that sets an interest rate r for loans and deposits. If 1+ r is the reciprocal of the discount factor, and if agents must bid for consumption in each period before knowing their income, then there is no inflation. However, there is an inflationary trend if agents know their income before bidding. We also consider a model with an active central bank, which is both accurately informed and flexible in its ability to change interest rates. This, however, may not be sufficient to control inflation.

Suggested Citation

  • Ioannis Karatzas & Martin Shubik & William D. Sudderth & John Geanakoplos, 2001. "Inflationary Bias in a Simple Stochastic Economy," Working Papers 01-09-054, Santa Fe Institute.
  • Handle: RePEc:wop:safiwp:01-09-054
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    Keywords

    Inflation; strategic market game; control; interest rate; central bank; equilibrium;

    JEL classification:

    • C7 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory
    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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