Long-term Contracts and the Optimal Choice of Monetary Instruments

Abstract

This paper studies the implications of long-term contracts for the optimal choice of a monetary instrument. it shows that an increase in the (average) contract length of the economy enables the monetary authority to reduce output variance under either instrument, the interest rate or the money stock. However, an interest rate policy seems to reduce the variance proportionately more than a money stock policy. Nevertheless, the choice of the optimal instrument is invariant with respect to the contract length.