Optimal Monetary Noise in an Economy with Bayesian Consumers and Risk-Averse Investors

Autonomous demand shock affects consumption spending. Variation in consumption spending contributes to the volatility in aggregate demand. As the investor is risk averse, volatility of aggregate demand reduces investment. Government injects monetary noise to reduce the volatility in aggregate demand and induce higher investment. The monetary noise clouds the observation of the autonomous aggregate demand by the consumer. The consumer forms Bayesian beliefs which are consistent with the equilibrium they supported for forecasting autonomous aggregate demand and monetary noise. With a greater monetary noise, the consumer relies less on the inaccurate observation of autonomous aggregate demand and more on the prior distribution functions of autonomous aggregate demand and monetary noise to decide on the level of consumption spending. Consumption spending therefore reflects less of the volatility in autonomous aggregate demand. Faced with a less volatile consumption spending, the investor increases investment