Seasonality and Monetary Policy∗

Seasonal fluctuations are as large as cyclical fluctuations. Monetary policy in the U.S. has dealt with seasonality by smoothing nominal rates of interest. The original motivation for this was that seasonality in nominal interest rates put recurring strain on the banking system. We build a model of monetary policy in the presence of seasonality which puts financial market conditions in the foreground. Our findings are as follows. Insulating nominal rates of interest or rates of inflation from seasonal variation is a formula for generating indeterminacy of equilibria and excess volatility. Preventing seasonality in the rate of money growth does not suffer from this problem. Moreover, under any method for conducting monetary policy, the setting of the target value of the monetary instrument will affect the degree of seasonal variability in most endogenous variables. This is a new channel by which monetary policy can have real effects. The case for eliminating seasonality in nominal rates of interest is strongest when seasonal impulses derive from shifts in money demand. It is weakest when seasonal impulses derive from the real sector.