Christian A. Stoltenberg

Money Demand and Macroeconomic Stability Revisited

This paper examines how money demand induced real balance effects contribute to the determination of the price level, as suggested by Patinkin (1949,1965), and if they affect conditions for local equilibrium uniqueness and stability. There exists a unique price level sequence that is consistent with an equilibrium under interest rate policy, only if beginning-of-period money enters the utility function. Real money can then serve as a state variable, implying that interest rate setting must be passive for unique, stable, and non-oscillatory equilibrium sequences. When end-of-period money provides utility, an equilibrium is consistent with infinitely many price level sequences, and equilibrium uniqueness requires an active interest rate setting. The stability results are, in general, independent of the magnitude of real balance effects, and apply also when prices are sticky. In contrast, under a constant money growth policy, equilibrium sequences are (likely to be) locally stable and unique for all model variants.

Policy Announcements and Welfare

In the presence of idiosyncratic risk, the public revelation of information about uncertain aggregate outcomes such as policy choices can be detrimental to social welfare. By announcing informative signals on non-insurable aggregate risk, the policy maker distorts agents’ insurance incentives and increases the riskiness of the optimal allocation that is feasible in self-enforceable arrangements. As an application, we consider a monetary authority that may reveal changes in the inflation target, and document that the negative effect of distorted insurance incentives can very well dominate conventional effects in favor for the release of better information.

Nested models and model uncertainty

Uncertainty about the appropriate choice among nested models is a central concern for optimal policy when policy prescriptions from those models differ. The standard procedure is to specify a prior over the parameter space ignoring the special status of some sub-models, e.g. those resulting from zero restrictions. This is especially problematic if a models generalization could be either true progress or the latest fad found to fit the data. We propose a procedure that ensures that the specified set of sub-models is not discarded too easily and thus receives no weight in determining optimal policy. We find that optimal policy based on our procedure leads to substantial welfare gains compared to the standard practice.

Monetary Policy and the Transaction Role of Money in the US

The declining importance of money in transactions can explain the well‐known fact that US interest rate policy was passive in the pre‐Volcker period and active after 1982. We generalise a standard cashless new Keynesian model (Woodford, 2003) by incorporating an explicit transaction role for money. In the pre‐Volcker period, we estimate that money did play an important role and determinacy required a passive interest rate policy. However, after 1982, money no longer played an important role in facilitating transactions. Correspondingly, the conventional view prevails and an active policy ensured equilibrium determinacy.

Reconciling consumption inequality with income inequality

The rise in within-group consumption inequality in response to the increase in within-group income inequality over the last three decades in the U.S. is puzzling to expected-utility-based incomplete market models. The two-sided lack of commitment models exhibit too little consumption inequality while the standard incomplete markets models tend to predict too much consumption inequality. We show that a model with two-sided lack of commitment and chance attitudes, as emphasized by prospect theory, can explain the relationship and can avoid the systematic bias of the expected utility models. The chance attitudes, such as optimism and pessimism, imply that the households attribute a higher weight to high and low outcomes compared to their objective probabilities. For realistic values of risk aversion and of chance attitudes, the incentives for households to share the idiosyncratic risk decrease. The latter effect endogenously amplifies the increase in consumption inequality relative to the expected utility model, thereby improving the fit to the data.