Price Volatility Under Alternative Monetary Instruments

Alfonso Novales

No 9306, Documentos de Trabajo del ICAE from Universidad Complutense de Madrid, Facultad de Ciencias Económicas y Empresariales, Instituto Complutense de Análisis Económico

Abstract: When private agents have difficulty in interpreting price fluctuacions, they are led into suboptimal allocations of resources. Consequently, price uncertainty is an undesirable feature of a business cycle. However, the way how monetary po1icy is implemented may influence the size of the unpredictable component of price fluctuacions and hence, the welfare of the private agents in the economy. This paper addresses the long standing issue of the optimal choice of a monetary instrument under uncertainty. Ina money-in the-utility function modeL it is shown that this is far from being a purely monetary issue, and also that the optirnal choice of instrument depends on the fiscal policy in effect. If the Govemment collects enough taxes, relative to its expenditures, a nominal interest rate policy produces a more stable price level, the opposite being true when taxes are low, relative to Government expenditures.

Keywords: Price; Volatility. (search for similar items in EconPapers)
Pages: 24 pages
Date: 1993
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