A note on inflation uncertainty and monetary policy

In this note we analyze the policy implications of a negative effect from inflation uncertainty on output. The negative effect is formalized by introducing inflation uncertainty effects into the aggregate supply function generated by Fischer's model of overlapping wage contracts. This modification brings about two major changes in the usual results. The long-run neutrality of monetary policy is lost, and the case for intervention is weakened. These changes follow since monetary policy will affect the variance of inflation and, hence, real output through its effect in the labor market.