While there is a consensus that monetary policy must be

Transcription

1 Optimal Montary Policy in an Economy with Sticky Nominal Wags Evan F. Konig Rsarch Officr Fdral Rsrv Bank of Dallas Whil thr is a consnsus that montary policy must b conductd within a framwork in which popl ar confidnt of a low long-run inflation rat, thr is littl agrmnt on how th Fdral Rsrv ought to allow prics to rspond to shocks ovr th nar trm. This articl shows that th optimal montary policy rul has th Fdral Rsrv targt a gomtric wightd avrag of output and th pric lvl. Mor than thirty-fiv yars ago, Milton Fridman initiatd an intns ruls vrsus discrtion dbat by calling for th Fdral Rsrv to maintain constant growth of th mony supply (Fridman 1959). Th focus of this arly dbat was on whthr an activ montary policy or a passiv montary policy is mor succssful at stabilizing output. Ovr th yars, th dbat has continud, but its trms hav shiftd. First, larg swings in th vlocitis of th montary aggrgats hav ld many conomists to turn away from Fridman s constantmony-growth prscription, toward policy ruls that ar mor dirctly concrnd with output and prics. Scond, in a vry ral sns th dbat is no longr ovr ruls vrsus discrtion but which rul? It s now takn for grantd that th montary authority follows a rul of som kind albit a rul that may not b clarly articulatd and that may shift in rspons to changs in th composition of th authority s councils or changs in policymakrs undrstanding of how th conomy oprats. Th bhaviors of privat agnts ar conditiond on how thy xpct th montary authority to ract to futur shocks to th conomy (Lucas 1976). Consquntly, futur policy choics cannot b tratd as xognous. Finally, thr is incrasd rcognition that in montary affairs as in so many othr aras of lif xpdint policis ar rarly th bst policis. Morovr, to obtain a socially optimal outcom today may rquir that policymakrs find a way to convinc th privat sctor that shortsightd policis will not b pursud in th futur (Barro and Gordon 1983, Kydland and Prscott 1977). In particular, th xprinc of th 1970s has ld to a consnsus that th privat sctor must nvr b givn grounds for doubting th Fdral Rsrv s commitmnt to long-run pric stability. Whil thr is a consnsus that montary policy must b conductd within a framwork in which popl ar confidnt of a low long-run inflation rat, thr is littl agrmnt on how th Fdral Rsrv ought to allow prics to rspond to shocks ovr th nar trm. This articl attmpts to shd light on th short-run stabilization issu within th contxt of an conomy subjct to productivity shocks, with sticky nominal wags. Th articl shows that th optimal montary policy rul in such an conomy has th Fdral Rsrv targt a gomtric wightd avrag of output and th pric lvl. In a ralistic spcial cas, th montary authority should targt nominal spnding. 24

2 Th analysis is subjct to a numbr of limitations. Th modl conomy is not subjct to any disturbancs othr than aggrgat productivity shocks. Thr is no attmpt to xplicitly modl th advrs ffcts of inflation. Nor dos th articl modl how th Fdral Rsrv would actually go about implmnting altrnativ policy ruls. In th ral world, som ruls may hav fwr informational rquirmnts than othrs or may imply lss xtrm movmnts in policy instrumnts. Implmntation rrors ar likly to b smallr for such ruls, nhancing thir prformanc. This articl has implications that xtnd byond th short-run stabilization issu. Thus, this articl illustrats that ral-businss-cycl modls may accuratly dscrib th historical bhavior of an conomy and yt b a poor guid to policy. That a larg fraction of th businss cycl can b attributd to supply shocks may man not that montary policy is inffctiv but that th Fdral Rsrv has bn doing its job. Mor gnrally, nithr montary policy nor privat contracts should b analyzd in isolation. Policis optimal undr on systm of privat contracts may prform poorly undr a diffrnt systm. Convrsly, th prformanc of a givn systm of privat contracts may b snsitiv to th policy rul adoptd by th montary authority. A simpl modl of aggrgat supply This sction analyzs output dtrmination and optimal montary policy in a comptitiv conomy subjct to aggrgat productivity shocks. 1 Initially, all prics ar assumd to b prfctly flxibl, so that markts clar instantanously from priod to priod. In such an conomy, montary policy is irrlvant to shortrun output dtrmination. Th montary authority is, thrfor, fr to focus xclusivly on maintaining pric stability. Nxt, th mony wag rat is assumd to b st on priod in advanc, introducing th possibility that output may dviat from its markt-claring lvl in rspons to unxpctd shifts in th production function. Sinc th mony wag rat fails to ract to supply shocks in this conomy, th burdn of doing so falls on th montary authority. Th optimal policy rul has th montary authority targt a gomtric wightd avrag of output and th pric lvl. Insofar as th montary authority is succssful in implmnting th optimal rul, th ral conomy will bhav as if th mony wag rat is prfctly flxibl. Aggrgat supply with flxibl prics. Profit maximization implis that th rprsntativ comptitiv firm will hir labor up to th point whr th marginal product of labor quals th ral wag: (1) MP N = W/P, whr N dnots hours of work. Suppos, in particular, that output is producd according to th function (2) Y = ΘN 1 β /(1 β ), whr Y is output, 0 < β < 1 is a fixd paramtr, and Θ is a random productivity shock. Equation 1 is thn quivalnt to (1 ) θ βn = w p, whr lowrcas lttrs rprsnt logarithms of thir upprcas countrparts. Th dmand for labor is an incrasing function of th productivity shock and a dcrasing function of th ral wag. For any givn lvl of hours, a doubling of Θ doubls th marginal product of labor and, so, doubls th ral wag. Utility maximization implis that th rprsntativ houshold will supply labor up to th point whr th marginal rat of substitution btwn lisur and consumption quals th ral wag. Equivalntly, ach houshold will supply labor up to th point whr minus th marginal rat of substitution btwn labor and consumption quals th ral wag: (3) MRS N,C = W/P. If th rprsntativ houshold s utility function taks th form U (C,N ) = (C 1 α 1)/(1 α) N 1+λ /(1 + λ), whr C is consumption and α > 0 and λ > 0 ar fixd paramtrs, thn quation 3 is quivalnt to (3 ) λn + αc = w p. Th supply of labor is incrasing in th ral wag and dcrasing in consumption. To clos th modl, tak logarithms of quation 2: (2 ) y = (1 β )n + θ ln(1 β), and assum that all output is consumd, so that y can b substitutd for c in quation 3. Th markt-claring valus of output, th ral wag, and labor ar obtaind by simul- FEDERAL RESERVE BANK OF DALLAS 25 ECONOMIC REVIEW SECOND QUARTER 1995

3 tanously solving quations 1, 2, and 3 : [ α λ θ αβ 1 β ] (4) y* = A ( 1+ λθ ) ( β + λ ) ln( 1 β ), (5) ( w p)* = A ( + ) ln( ), and (6) n* = A ( 1 αθ ) + α ln( 1 β ), whr A [α + β(1 α) + λ] 1. Equations 4 and 5 say that a positiv productivity shock (an incras in θ ) raiss quilibrium output and th quilibrium ral wag. Th impact on quilibrium hours of work is ambiguous. Th highr ral wag that accompanis an incras in productivity tnds to incras th supply of labor. This substitution ffct is opposd, howvr, by a ngativ walth ffct: as output bcoms mor radily availabl, popl ar lss willing to work at any givn wag. In th ral world, hours of work pr prson hav changd rlativly littl dspit larg productivity gains. This obsrvation suggsts that α 1. If α = 1, th substitution and walth ffcts of an incras in productivity cancl. Equilibrium output and th quilibrium ral wag ris on-for-on with θ, whil quilibrium hours ar constant. Rgardlss of th valu of α, in a marktclaring conomy th volution of output is indpndnt of th volution of th pric lvl. Figur 1 Aggrgat Supply in Sticky-Wag and Flxibl-Wag Economis Th aggrgat supply curv is vrtical whn th mony wag is flxibl and upward sloping whn th mony wag is prdtrmind. p p y * (θ ) AS flxibl wag as sticky wag y Sinc thr is no short-run trad-off btwn output stability and pric stability, th montary authority can concntrat its fforts on achiving th lattr. Aggrgat supply with a prdtrmind mony wag. Prdtrmind nominal wags ar an oft-studid sourc of montary nonnutrality. 2 Morovr, th xistnc of maningful nominal wag rigiditis is consistnt with svral rcnt mpirical studis (Card 1990, Cho 1993, Cho and Cooly 1992, McLaughlin 1994). Accordingly, th rmaindr of this articl assums that th mony wag rat is st, on priod in advanc, at its xpctd markt-claring lvl and that firms hav discrtionary control ovr hours of work at th prst wag. 3 From quation 5, th mony wag will qual (7) w = p + A ( α + λ) θ αβln( 1 β), whr an suprscript indicats an xpctd valu conditiond on information availabl in th immdiatly prcding priod. With th mony wag st as abov, th rprsntativ firm s profit maximization condition (quation 1 ) implis that hours of work ar givn by (8) n = n * 1 + [( p p )+( α + λ) A( θ θ )] β. Substituting into th production function (quation 2 ), on obtains a formula for output: (9) y = y * 1 β + ( p p )+( α + λ) A( θ θ ) β. Output and mploymnt dviat from thir markt-claring lvls to th xtnt that th output pric or productivity dviats from valus xpctd at th tim th wag rat was st. Th intuition bhind ths rsults is straightforward. Considr, first, an unxpctd incras in th pric of output. For any givn productivity ralization, a surpris pric incras lowrs th ral wag. Firms mov down along thir labor dmand schduls, hiring mor labor (and xpanding production) as th ral wag falls. 4 Similarly, an incras in productivity causs firms labor dmand schduls to shift upward. In a markt-claring conomy, th positiv impact that this upward shift would othrwis hav had on quilibrium hours is partially offst by an incras in th wag rat as housholds mov out along thir labor supply schduls. Whn th mony wag is prdtrmind, this offst can occur only insofar as th productivity incras was xpctd. (Compar quation 5, which ap- 26

4 Figur 2 Th Rspons of Aggrgat Supply To Productivity Shocks Holding th pric lvl fixd at its xpctd valu, th sticky-wag aggrgat supply curv shifts farthr in rspons to productivity shocks than dos th flxibl-wag aggrgat supply curv. p AS (θ ) AS (θ ) AS (θ ) as (θ ) as (θ ) θ = θ > θ. Th corrsponding markt-claring output lvls ar dnotd y*(θ ), y*(θ ), and y *(θ ), rspctivly. Th montary authority would lik th conomy to nd up at point A [y *(θ ), p ] in th first cas, point B [y*(θ ), p ] in th scond cas, and point C [y *(θ ), p ] in th third cas. Mor gnrally, th montary authority would lik to rstrict th conomy to th lin passing through points A, B, and C. Evrywhr along this lin, y = y*. From quation 4, as θ riss from θ to θ, th markt-claring output lvl riss by y*( θ ) y*( θ ) = ( 1 + λ) A( θ θ ). p as (θ ) From quation 9, th pric lvl changs by p p = ( α + λ) A( θ θ ). Thrfor, th lin conncting points B and C has a slop of (α + λ)/(1 + λ), and th quation of th lin passing through points A, B, and C can b writtn y * (θ ) plis to th markt-claring cas, with quation 7.) Consquntly, surpris incrass in productivity hav a largr positiv impact on mploymnt and output than do anticipatd incrass. Graphically, th aggrgat supply curv in a flxibl-wag conomy is vrtical at y*. In contrast, th aggrgat supply curv in an conomy with prdtrmind wags is upward sloping. Figur 1 dpicts th cas whr θ = θ. Although both aggrgat supply curvs shift to th right in rspons to a positiv unanticipatd productivity shock, th sticky-wag aggrgat supply schdul shifts mor. Similarly, a ngativ unanticipatd productivity shock causs a largr lftward shift in th sticky-wag aggrgat supply curv than in th flxibl-wag aggrgat supply curv (Figur 2 ). Optimal policy. Comptitiv allocations ar fficint. Consquntly, policymakrs will want to kp th sticky-wag conomy as clos to th markt-claring allocation as possibl. Howvr, th markt-claring lvls of output and hours ar not, in gnral, dirctly obsrvabl. Fortunatly, this problm can b circumvntd. Considr a graphical rprsntation of th montary authority s problm. Figur 3, lik Figur 2, plots thr aggrgat supply curvs, on for th cas in which θ = θ < θ, on for th cas in which θ = θ, and on for th cas in which y or, quivalntly, α + λ ( p p ) = ( y y ) 1 + λ α + λ α + λ (10) p + y = p + y. 1+ λ 1+ λ Figur 3 Optimal Montary Policy In a sticky-wag conomy, optimal montary policy calls for th pric lvl to fall as output riss. p p p p AS (θ ) AS (θ ) AS (θ ) A y * (θ ) as (θ ) B y * (θ ) as (θ ) C y * (θ ) as (θ ) y FEDERAL RESERVE BANK OF DALLAS 27 ECONOMIC REVIEW SECOND QUARTER 1995

5 Thus, for th montary authority to guarant that priod-t output is optimal rgardlss of th valu of θ t, it is ncssary and sufficint that th authority adjust its policy instrumnts so as to st α + λ (11) pt + yt = st, 1 + λ whr s t is an arbitrary prannouncd targt. In th spcial cas whr th markt-claring lvl of mploymnt is invariant with rspct to productivity shocks (α = 1), quation 11 rducs to a nominal spnding targt: 5 (11 ) p t + y t = s t. Imprfct Implmntation of Optimal Policy Thr is only a loos connction btwn variabls that ar dirctly affctd by Fdral Rsrv actions (bank rsrvs and th fdral funds rat) and th variabls that ntr th optimal policy rul: aggrgat output and th aggrgat pric lvl. Consquntly, th Fdral Rsrv cannot b xpctd to maintain th rlationship displayd in quation 11 xactly. Th unanticipatd componnt of th rror that th Fdral Rsrv maks in trying to implmnt quation 11 plays th rol of an aggrgat dmand shock in th modl conomy. To s this, lt δ dnot th currnt-priod policy implmntation rror. That is, suppos that quation 11 is rplacd by α + λ p + y s + = + δ, 1 λ whr, as bfor, s is a prannouncd targt. This quation can b solvd for p and substitutd back into quations 8 and 9, yilding (aftr a littl manipulation) n n 1 = ( 1+ λ) ( δ δ ) + ( 1 α) ( θ θ ) α + β( 1 α) + λ y y 1+ λ = ( 1 β) ( δ δ ) + ( θ θ ). α + β( 1 α) + λ Hours rspond positivly to unanticipatd policy implmntation rrors and ambiguously to productivity shocks. 1 Output rsponds positivly to both unanticipatd implmntation rrors and productivity surpriss. Hnc, th prsnc of implmntation rrors incrass th chancs that hours of work will vary procyclically. This ffct is most obvious in th cas whr α = 1 and is spcially likly in th cas whr unanticipatd implmntation rrors (δ δ ) ar positivly corrlatd with aggrgat productivity shocks (θ θ ). Substitut from th output quation back into th policy rul to obtain p p 1 = 1+ + α + β 1 α + λ β ( λ ) ( δ δ ) ( ( ) α λ ) ( θ θ ). Thus, th pric lvl rsponds rsponds positivly to unanticipatd implmntation rrors and ngativly to aggrgat productivity shocks. Th ral wag, of cours, movs xactly opposit to th pric lvl. 1 As a tchnical mattr, th anticipatd componnt of th implmntation rror can always b foldd into th prannouncd targt, s. That is, on can without loss of gnrality assum δ 0. Not that th optimal policy rul dos not rquir that th montary authority obsrv th ralizd valus of productivity disturbancs. Insofar as th montary authority is succssful in implmnting a policy rul of th form givn in quation 11, it will appar that businsscycl fluctuations can b ntirly attributd to aggrgat productivity shocks and this will, indd, b th cas. 6 Howvr, it would b incorrct to us this obsrvation as a basis for concluding that montary policy is inffctiv or unimportant. Th analysis prsntd abov also illustrats a mor gnral point: montary policy and privat contracting arrangmnts should b analyzd as a packag. Clarly, optimal montary policy dpnds upon privat contracting arrangmnts. In th xampl abov, th policy rul givn in quation 11 would not b optimal (or vn fasibl) in an conomy whr it was th pric lvl rathr than th wag rat that was sticky. 7 Prhaps lss obviously, privat agnts may rly upon th montary authority to pursu policis that mak complicatd contingnt contracts unncssary. Altrnativ vrsions of th optimal policy rul W hav sn that th optimal policy rul in a sticky-wag conomy has th gnral form p t + ay t = s t (compar quation 11). No rstrictions ar placd on th pric output targt, s t, xcpt for th rquirmnt that it b announcd on priod in advanc. 8 This sction shows that a numbr of prominnt proposd policy ruls also hav this gnral form. Som of ths ruls ar nvrthlss suboptimal, bcaus thy put too littl wight on output. Othr ruls ar optimal only undr crtain conditions. Pric-lvl and inflation targting. Undr a pric-lvl targt, s t is a constant (or, mor gnrally, a dtrministic function of tim), and a is st qual to 0. Undr an inflation targt, a is again st qual to 0, but s t is dfind to qual p t 1 (or p t 1 plus a constant). Although th pric-lvl and inflation targting ruls hav th sam gnral form as th optimal policy rul, thy ar not thmslvs optimal bcaus thy put zro wight on shortrun output stabilization. In Figur 3, th priclvl and inflation targting ruls would confin th conomy to a horizontal lin through point B, rathr than th downward sloping lin through points A and C. Consquntly, output fluctuats too much in rspons to productivity shocks undr ths ruls. 28

6 Mor formally, if strictly adhrd to, th pric-lvl and inflation targting ruls imply that thr ar no pric surpriss: p t = p t. But quation 9 tlls us that in a sticky-wag conomy, pric surpriss must partially offst productivity surpriss if th conomy is to achiv th marktclaring allocation. Th Hall and Taylor output-gap ruls. Robrt Hall (1984) and John Taylor (1985) hav proposd that th Fdral Rsrv adopt a policy rul of th form (p t p T t ) + a (y t y T t ) = 0, whr p T and y T ar a targt pric lvl and targt t t output lvl, rspctivly, and whr a > 0. Rarranging trms to obtain (12) p t + ay t = p T t + ay T t, w s that th Hall and Taylor ruls will hav th sam form as th optimal rul drivd hr providd that p T and y T ar known on priod t t in advanc. Full optimality also rquirs that a = (α + λ)/(1 + λ). In Hall s analysis, th pric targt is a constant. In Taylor s analysis, p T = p. In ithr t t 1 cas, th pric targt is known as of priod t 1. Both analyss assum that th output gap, (y t y T ), is stationary. Thrfor, targt output and t actual output must hav a common prmannt componnt. If y t is stationary about a dtrministic trnd, it is natural to st targt output qual to trnd output. Th right-hand sid of quation 12 will b known as of priod t 1. Consquntly, th Hall and Taylor ruls will hav th optimal form. If output s prmannt componnt is a random walk with drift, th situation is a littl mor complicatd. It will not do to st y T t qual to currnt-priod prmannt incom, bcaus priod-t prmannt incom is stochastic from th prspctiv of priod t 1. Howvr, it would b consistnt with optimality to st y T t qual to th prvious priod s prmannt incom plus a constant qual to th drift in prmannt incom. Nominal incom lvl and nominal incom growth ruls. Th simplst vrsions of th optimal policy rul st s t qual to a dtrministic function of tim or qual to (p t 1 + ay t 1 ) plus a constant. In particular, if output growth varis about a wll-dfind long-run man, E ( y), thn stting s t qual to ae( y)t + s 0 or qual to ae ( y) + (p t 1 + ay t 1 ) whr a = (α + λ)/(1 + λ) will yild a policy rul that is optimal and that yilds a zro long-run avrag rat of inflation. In th spcial cas whr α = 1 (so that also a = 1), ths dfinitions yild a nominal GDP lvl rul and a nominal GDP growth rul, rspctivly. Discussion. How is it that so many smingly vry diffrnt ruls can all b optimal? What mattrs for short-run stabilization purposs is only th rlationship btwn unxpctd pric and output changs. Equation 11, which dfins th optimal policy rul, lavs ntirly opn how this priod s xpctd pric lvl should dpnd upon past ralizations of output and prics. Diffrncs btwn ruls along this dimnsion may hav important implications for th distribution of walth, particularly if dbt contracts ar spcifid in nominal trms. Additionally, som vrsions of th optimal rul may b asir than othrs for th montary authority to implmnt. Such considrations ar outsid th scop of this articl. Summary and concluding rmarks Output and mploymnt tnd to b too rsponsiv to aggrgat productivity shocks in sticky-wag conomis. Montary policy can offst this tndncy by allowing th pric lvl to fall whn output is high and allowing th pric lvl to ris whn output is low. Undr optimal montary policy, th conomy rsponds to productivity shocks xactly as it would in a flxiblwag conomy. Thus, dspit a prst mony wag, thr ar no $20 bills lying on th sidwalk: thr is no loss of conomic fficincy. Th optimal policy is sufficintly gnral in form to ncompass svral wll-known policy proposals, including thos of Robrt Hall and John Taylor. In th ralistic spcial cas in which th markt-claring lvl of mploymnt is indpndnt of productivity, it is optimal for th montary authority to targt nominal spnding. It is, of cours, possibl that privat contracts would adapt if th montary authority insistd upon pursuing som policy othr than that optimal in a sticky-wag conomy. 9 Th procss of adaptation would likly tak som tim, howvr, and might nvr b complt. To minimiz transition costs, a montary authority choosing to implmnt som policy othr than that optimal undr currnt contracting arrangmnts would nd to announc its intntions wll in advanc. Th particular modling framwork usd in this articl is unralistic in its simplicity, and th dtails of th optimal policy rul drivd hr ar snsitiv to changs in modl spcification. Howvr, minor changs in th modl ar unlikly to affct th articl s principal conclusions: FEDERAL RESERVE BANK OF DALLAS 29 ECONOMIC REVIEW SECOND QUARTER 1995

7 1. In a sticky-wag conomy, th Fdral Rsrv has a short-run output stabilization rol to play. 2. Svral variants of a givn rul may hav idntical short-trm stabilization proprtis. Consquntly, in choosing btwn variants, distributional considrations and diffrncs in as of implmntation will likly prov dcisiv. 3. Th fraction of output variation that can b attributd to aggrgat productivity shocks convys littl usful information about th importanc or ffctivnss of montary policy. 4. Th prformanc of a givn systm of privat contracts is snsitiv to th policy rul adoptd by th montary authority. Convrsly, policis optimal undr on systm of privat contracts may prform poorly undr a diffrnt systm. Thus, nithr montary policy nor privat contracts should b analyzd in isolation. Nots Finn Kydland and Mark Wynn offrd hlpful commnts for this articl. 1 Th analysis xtnds Ban (1983) to th cas whr labor supply is drivd xplicitly from utility maximization an xtnsion that has important implications for th circumstancs undr which targting nominal spnding is optimal. 2 S, for xampl, Fischr (1977), Gray (1978), and Taylor (1980). 3 Prhaps rlocation costs ar ngligibl if workrs switch jobs on priod in advanc and prohibitiv othrwis. Thn th labor markt will b comptitiv x ant and monopsonistic x post. Workrs will insist that som of th trms of thir mploymnt b splld out in advanc. Prstting th nominal wag, whil giving firms control of hours, is an approach that is oftn obsrvd in practic (Card 1990). Th assumption that th wag is st qual to its xpctd marktclaring lvl is standard in th litratur. In th modl dvlopd hr, this assumption implis no loss of fficincy. 4 If montary-policy-inducd pric surpriss wr th primary driving forc bhind macroconomic fluctuations, it would follow that th ral wag ought to b countrcyclical. Sinc th ral wag is not, in fact, countrcyclical, conomists with strong priors that montary policy drivs th macroconomy hav in rcnt yars tndd to favor modls of pric stickinss ovr modls of wag stickinss. S, for xampl, Ball and Mankiw (1994). 5 In contrast, Ban (1983) finds that a nominal spnding targt is optimal only if labor is inlastically supplid a problmatic assumption whn firms ar givn shortrun control of hours. In gnral, a nominal spnding targt is optimal only if n* is indpndnt of productivity shocks. Bcaus Ban uss an ad hoc labor supply function that lacks a walth ffct, th only way that h can mak n* indpndnt of θ is by making th supply of labor indpndnt of th ral wag. In th modl dvlopd hr, in contrast, n* is indpndnt of θ whnvr α = 1 (compar quation 6). 6 Th box ntitld Imprfct Implmntation of Optimal Policy discusss th bhavior of th conomy whn th optimal policy is implmntd with rror. 7 For discussion of optimal policy in an conomy with sticky output prics, s Irland (1994). 8 Mor prcisly, th targt must b announcd arly nough that all labor contracts will b rngotiatd bfor th targt bcoms binding. Th ral-world countrpart to on priod is, thus, probably on to thr yars. 9 This point is not nw. According to Fischr (1977, 204), An attmpt by th montary authority to xploit th xisting structur of contracts to produc bhavior far diffrnt from that nvisagd whn contracts wr signd would likly lad to th ropning of th contracts and, if th nw bhavior of th montary authority wr prsistd in, a nw structur of contracts. Rfrncs Ball, Lawrnc, and Grgory Mankiw (1994), A Sticky- Pric Manifsto, Carngi Rochstr Confrnc Sris on Public Policy 41 (Dcmbr): Barro, Robrt J., and David Gordon (1983), A Positiv Thory of Montary Policy in a Natural Rat Modl, Journal of Political Economy 91 (August): Ban, Charls R. (1983), Targting Nominal Incom: An Appraisal, Economic Journal 93 (Dcmbr): Card, David (1990), Unxpctd Inflation, Ral Wags, and Employmnt Dtrmination in Union Contracts, Amrican Economic Rviw 80 (Sptmbr): Cho, Jang-Ok (1993), Mony and th Businss Cycl with On-Priod Nominal Contracts, Canadian Journal of Economics 26 (August): , and Thomas F. Cooly (1992), Th Businss Cycl with Nominal Contracts (Qun s Univrsity, Dcmbr, unpublishd manuscript). Fischr, Stanly (1977), Long-Trm Contracts, Rational Expctations, and th Optimal Mony Supply Rul, Journal of Political Economy 85 (Fbruary): Fridman, Milton (1959), A Program for Montary Stability (Nw York: Fordham Univrsity Prss). 30

8 Gray, JoAnna (1978), On Indxation and Contract Lngth, Journal of Political Economy 86 (Fbruary): Lucas, Robrt E., Jr. (1976), Economtric Policy Evaluation: A Critiqu, Journal of Montary Economics 1 (Supplmnt), Hall, Robrt E. (1984), Montary Stratgy with an Elastic Pric Standard, in Pric Stability and Public Policy (Kansas City: Fdral Rsrv Bank of Kansas City), Irland, Ptr N. (1994), Montary Policy with Nominal Pric Rigidity (Fdral Rsrv Bank of Richmond, May, unpublishd manuscript). Kydland, Finn E., and Edward C. Prscott (1977), Ruls Rathr than Discrtion: Th Inconsistncy of Optimal Plans, Journal of Political Economy 85 (Jun): McLaughlin, Knnth J. (1994), Rigid Wags? Journal of Montary Economics 34 (Dcmbr): Taylor, John B. (1980), Aggrgat Dynamics and Staggrd Contracts, Journal of Political Economy 88 (Fbruary): (1985), What Would Nominal GDP Targting Do to th Businss Cycl? Carngi Rochstr Confrnc Sris on Public Policy 22 (Spring): FEDERAL RESERVE BANK OF DALLAS 31 ECONOMIC REVIEW SECOND QUARTER 1995