On the optimality of interest rate smoothing

This paper studies some continuous-time cash-in-advance models in which int erest rate smoothing is optimal. We consider both deterministic and stochas tic models. In the stochastic case we obtain two results of independent int erest: (i) we study what is, to our knowledge, the only version of the neoc lassical model under uncertainty that can be solved in closed form in conti nuous time; and (ii) we show how to characterize the competitive equilibriu m of a stochastic continuous time model that cannot be computed by solving a planning problem. We also discuss the scope for monetary policy to improv e welfare in an economy with a suboptimal real competitive equilibrium, foc using on the particular example of an economy with externalities. (C) 1999 Elsevier Science B.V. All rights reserved. JEL classification: E31; E48; E5 2; O42.