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A Note on the Role of Ambiguity in a Monetary Policy Game

Vincenzo Denicolo' ()

The Manchester School of Economic & Social Studies, 1998, vol. 66, issue 5, 571-80

Abstract: This paper shows that a policymaker may deliberately choose not to minimize monetary variability. The policymaker has an incentive to create unexpected inflation so as to stimulate economic activity via a Lucas supply curve. In equilibrium, however, the public correctly anticipates the monetary policy and, therefore, the economy settles to the natural rate of employment with positive inflation. The equilibrium is socially inefficient. Since the slope of the Lucas supply curve is inversely related to the variance of monetary shocks, a positive variance of money growth reduces the policymaker's incentive to inflate and, therefore, may be welfare improving. Copyright 1998 by Blackwell Publishers Ltd and The Victoria University of Manchester

Date: 1998
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