Price stabilizing, Pareto improving policies (Q540418)

The paper studies a simple three period overlapping generations (OLG) model with incomplete markets and shows that stabilisation may be welfare improving. Volatility of endogenous variables is created by volatility in demand and supply. Thus, curbing price volatility must be done by limiting, directly or indirectly, the actions of agents. There, is then a trade-off which can be described as follows considering the individual agent's point of view: the ideal policy should limit the actions of all other agents in order to reduce the (price) volatility he is facing, but would allow him to act freely. This trade-off is exposed in this paper, and some conditions for when a stabilising policy is beneficial are provided motivated by an interest in understanding the relationship between rational beliefs and optimality. To this end, the OLG model is first described, discussed and interpreted. Then, the features of the monetary equilibria are studied and the policy results are provided. Finally, the case of contemporaneously diverse beliefs is briefly considered, where it turns out that implementation of Pareto improving reallocations is more involved.