UNANTICIPATED MONEY GROWTH AND THE BUSINESS-CYCLE RECONSIDERED

The role of unanticipated changes in money growth for aggregate fluctu ations is reexamined using the methods of quantitative equilibrium bus iness cycle theory. A stochastic growth model with money is constructe d in which production and trade take place in spatially separated mark ets (islands). Following Lucas (1972, 1975), individuals only observe prices in their own local market, causing them to confuse changes in t he average price level with changes in market-specific relative prices . We show that this mechanism can lead to large fluctuations in real e conomic activity. Some aspects of the statistical properties of these fluctuations, however, differ significantly from those describing U.S. business cycles.