INFLATION, NOMINAL INTEREST-RATES AND THE VARIABILITY OF OUTPUT

This paper examines the distribution of output around capacity when mo ney demand is a nonlinear function of the nominal interest rate such t hat nominal interest rates cannot become negative. When fluctuations i n output result primarily from disturbances to the money market, the v ariance of output is shown to be an increasing function of the trend i nflation rate. When they result from disturbances to the goods market, the variance of output is a decreasing function of the trend inflatio n rate. When both disturbances are significant, there exists, in gener al, a critical non-zero trend inflation rate that minimizes the varian ce of output. (C) 1998 Elsevier Science B.V. All rights reserved.