Review

This article was originally presented as a speech at the Charlotte Economics Club, Charlotte, North Carolina, February 25, 2004.

This article analyzes how announced surprises in monetary policy actions and macroeconomic data releases affect the average rate of inflation that economic agents expect to prevail over the 10-year period following the surprise. 

Many authors have found that the capital asset pricing model (CAPM) does not explain stock returns—possibly because it is only a special case of Merton's (1973) intertemporal CAPM under the assumption of constant investment opportunities (e.g., a constant expected equity premium). This article explains the progress that has been made by dropping the assumption that expected returns are constant. 

The authors study the welfare cost of inflation in a general equilibrium life-cycle model that includes households that live for many periods, production and capital, simple monetary and financial sectors, and a fairly elaborate government sector.