Optimal Choice of Monetary Instruments in an Economy with Real and Liquidity Shocks

Faced with real and nominal shocks, what should a benevolent central bank do, \u85 x the money growth rate or target the ination rate? In this paper, we make a \u85rst attempt at studying the optimal choice of monetary policy in-struments in a micro-founded model of money. Speci\u85cally, we produce an overlapping generations economy in which limited communication and stochas-tic relocation creates an endogenous transactions role for \u85at money. We \u85nd that when the shocks are real, welfare is higher under money growth targeting; when the shocks are nominal and not large, welfare is higher under ination rate targeting. While under ination rate targeting, it is always optimal to pur-sue an expansionary policy, it is never optimal to do so under money growth targeting. JEL Classi\u85cation: E31, E42, E6