MONETARY NEUTRALITY AND OPTIMALITY IN EQUILIBRIUM MODELS WITH PRIVATE INFORMATION AND A SINGLE ASSET

Abstract

The neutrality and optimality of countercyclical monetary policy are examined in a representative linear economy featuring competitive equilibria in multiple markets, a single asset, a general monetary feedback rule and rational expectations based on a general representation of private information. Four propositions are developed: (1) a necessary and sufficient condition for the countercyclical neutrality of monetary policy under all possible forms of private information in such an economy is stated in terms of restrictions on the parameters of the monetary feedback rule; (2) a necessary and sufficient condition for countercyclical neutrality under common incomplete information is developed as a corollary; (3) a necessary and sufficient condition for the allocational neutrality of monetary policy is stated in terms of an alternative set of parameter restrictions; (4) optimal monetary feedback is fully characterized and shown to completely stabilize deviations in market output by eliminating the influence of those current stochastic innovations agents cannot directly observe from the expectations formed by agents. These conditions also serve to unify the diverse propositions about monetary neutrality and optimality in linear equilibrium macroeconomic models appearing in Barro (1976), Barro and Fischer (1976), Asako (1982), King (1982), Waldo (1982), Marini (1985), Andersen (1986), and Nickerson (1987).