On the Non-neutrality of Money with Incomplete Markets

In this paper we show that if markets are incomplete and there are nominal assets, whose payoff is denominated in money, monetary policy will be in general non-neutral. The mechanism through which monetary policy operates is a change in the structure of the rates of return: by changing the level of money prices monetary policy affects the payoffs of nominal assets. This differs from previous arguments for non-neutrality. We also show that a consideration of this effect of monetary policy may allow us to claim the superiority, from a welfare point of view, of a random money growth rate over a deterministic one. Journal of Economic Literature Classification Numbers: D52, E50, G10. © 1994 Academic Press, Inc