The inflationary bias of real uncertainty and the harmonic Fisher equation (Q2502351)

The goal of this paper is to understand the behavior of prices and money in a simple, stationary economy with exogenous production subject to independent identically distributed shocks. It is shown that there is a unique, neutral stationary equilibrium, both for the case when the economy has no loan market and also when there is a central bank that sets an interest rate \(\rho\), the same for both savers and borrowers. With help of the Fisher equation, the long-run rate of inflation is calculated exactly as a function of the interest rate \(\rho\) and the distribution of the random shocks. The analysis is formaluted in terms of a representative agent with an arbitrary concave utility function, a single good, and independent, identically distributed endowments. An explicit formula for a unique neutral stationary equilibrium is derived. Also it is shown that if the agents do not know their endowments before they are called upon to commit themselves to expenditures, then the original Fisher equation is restored irrespectively of the agent's utility function. Finally it is noted that the interest rate pertains to the trading period; an agent who wishes to sell in order to raise the revenue, to make a simultaneous purchase, must borrow the money at rate \(\rho\).