Monetary Bands and Monetary Neutrality

Abstract

This paper attempts to provide an explanation of the short-run monetary non-neutrality in an economy where agents have full current information and no nominal prices are set in advance. This non-neutrality arises due to the government's setting of nominal target bands. If the current money supply is near the upper bound of the band, any increase in money supply will require the monetary authority to take immediate action to reduce it. This serves to decrease the expected rate of inflation, thus increasing the demand for real balances and production. This paper also shows that if readjustments of nominal target bands are likely to occur, then the positive effect of money on output becomes attenuated.