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Optimal monetary policy: distribution efficiency versus production efficiency
Author(s) -
Xiang Haitao
Publication year - 2013
Publication title -
canadian journal of economics/revue canadienne d'économique
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.773
H-Index - 69
eISSN - 1540-5982
pISSN - 0008-4085
DOI - 10.1111/caje.12041
Subject(s) - economics , monetary economics , monetary policy , production (economics) , market liquidity , distribution (mathematics) , unobservable , inflation (cosmology) , bond market , welfare , consumption (sociology) , bond , microeconomics , econometrics , finance , mathematical analysis , social science , physics , mathematics , theoretical physics , market economy , sociology
This paper investigates the trade‐off between distribution effect and production effect of monetary policy when there exist unobservable idiosyncratic liquidity shocks. In the absence of risk‐sharing arrangements such as a credit market, monetary policy serves to provide ex post insurance to smooth consumption. Specifically, issuing interest‐bearing bonds restores credit transactions on money through bond‐money exchanges. Such a policy has a positive distribution effect, but the resulting inflation hampers production efficiency. It is demonstrated that the trade‐off between distribution efficiency gain and production efficiency loss would result in net welfare enhancement if consumers are relative‐risk‐averse enough.