Asset Pricing in a Monetary Economy with Heterogeneous Beliefs

In this paper, we shed new light on the role of monetary policy in asset pricing by focusing on the case where investors have heterogeneous expectations about future monetary policy. This case is realistic, because central banks are typically less than perfectly open on their intentions. Accordingly, surveys of economists in the press reveal that they frequently disagree in their expectations. Under heterogeneity in beliefs, investors place bets against each other on the evolution of the money supply, and as a result, the sharing of wealth in the economy evolves stochastically over time, making money non-neutral. Employing a continuous-time, general equilibrium model, we establish these fluctuations to be rich in implications, in that they majorly affect the equilibrium prices of all assets, as well as inflation. In some specific cases, we are able to derive explicit formulas for important economic quantities. In particular, we find that the stock market volatility may be significantly increased by the heterogeneity in beliefs. In addition to generating interesting behavior on the part of asset prices, our model provides a natural framework in which to assess the impact of the transparency of monetary policy, a topical and controversial issue. Our model is particularly appropriate for the study of the effects of transparency, because it is intuitive that one of the key effects of increased transparency should be a drop in the amount of heterogeneity in beliefs.