The correlations and volatilities of real variables seem to be stable over
time, but the relation between real and nominal variables is unstable. Pres
umably, one important factor behind this observation is the nature of money
supply. In this paper, I look at a business cycle model where the central
bank sets money supply to minimize the volatility of inflation and output.
I find that small changes in the central bank's preferences can generate la
rge changes in the derived money supply rule and in correlations between re
al and nominal variables. Although wages are assumed to be sticky, changes
in the money supply rule do not generate any major changes in the behavior
of real variables. (C) 2000 Elsevier Science B.V. All rights reserved. JEL
Classification: E32; E52.