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Efficient Propagation of Shocks and the Optimal Return of Money

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Author Info
Ricardo Cavalcanti
Andres Erosa

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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

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Paper provided by Society for Economic Dynamics in its series 2006 Meeting Papers with number 738.

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Date of creation: 03 Dec 2006
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Handle: RePEc:red:sed006:738

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Related research
Keywords: Mechanism Design monetary theory history dependence

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Find related papers by 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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