Optimal Monetary Policy and Correlation between Prices and Output

University of Alabama Department of Economics, Finance and Legal Studies Working Paper No. 00-08-05

29 Pages Posted: 25 Sep 2000

See all articles by James Peery Cover

James Peery Cover

University of Alabama - Department of Economics, Finance and Legal Studies

Paul Pecorino

University of Alabama - Department of Economics, Finance and Legal Studies

Date Written: August 2000

Abstract

Several authors have reported finding a negative correlation between prices and output for the U.S. in the post WW II data. This paper presents a simple aggregate supply and demand model to show that this correlation may reflect the actions of an optimizing monetary policy maker rather than the relative sizes of the aggregate demand and supply shocks which hit the economy. Because the optimizing policy maker seeks to offset fully the effects of aggregate demand shocks, when the policy maker views these shocks with greater precision, the observed correlation of prices and output falls and can become negative. Importantly, our model is consistent with the observed changed in the price-output correlation between the pre WW II and post WW II periods.

Keywords: optimal monetary policy, price-output correlation

JEL Classification: E3, E5

Suggested Citation

Cover, James Peery and Pecorino, Paul, Optimal Monetary Policy and Correlation between Prices and Output (August 2000). University of Alabama Department of Economics, Finance and Legal Studies Working Paper No. 00-08-05, Available at SSRN: https://ssrn.com/abstract=240369 or http://dx.doi.org/10.2139/ssrn.240369

James Peery Cover

University of Alabama - Department of Economics, Finance and Legal Studies ( email )

P.O. Box 870244
Tuscaloosa, AL 35487
United States
205-348-8977 (Phone)
205-348-0590 (Fax)

Paul Pecorino (Contact Author)

University of Alabama - Department of Economics, Finance and Legal Studies ( email )

P.O. Box 870244
Tuscaloosa, AL 35487
United States
205-348-0379 (Phone)
205-348-0590 (Fax)

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