Optimal Choice of Monetary Instruments in anEconomy with Real and Liquidity Shocks

Faced with real and nominal shocks, what should a benevolent central bankdo, …x the money growth rate or target the inflation rate? In this paper, wemake a …rst attempt at studying the optimal choice of monetary policy in-struments in a micro-founded model of money. Speci…cally, we produce anoverlapping generations economy in which limited communication and stochas-tic relocation creates an endogenous transactions role for …at money. We …ndthat when the shocks are real, welfare is higher under money growth targeting;when the shocks are nominal and not large, welfare is higher under inflationrate targeting. While under inflation rate targeting, it is always optimal to pur-sue an expansionary policy, it is never optimal to do so under money growthtargeting.[...]