The potential of monetary policy to stabilize fluctuations in output and employment is demonstrated in a stochastic rational expectations model in which firms choose, considering average profitability, to set prices in advance of the period when they apply to goods sold. This lead time in pricing decisions increases the fluctuations of output about the normal employment level. But proper use of a feedback monetary policy rule can reduce these fluctuations even though expectations are rational and people know the policy rule. It is noted that use of a rule-dictated policy sometimes requires the monetary authorities to penalize the economy in the short run for the sake of beneficial system effects of the rule upon the relevant steady-state distributions.

[An embargo probability leads to private adjustments to curtail consumption and expand production, raising marginal value of consumption less than of production. If there are unemployment or foreign policy externalities, there is an optimal tariff which is proportional to foreign dependence, is inversely proportional to elasticity of external embargo loss, varies directly with embargo probability, and depends more complexly on other parameters. Stockpiling should limit embargo price rise to unit cost of storage divided by embargo frequency. With low embargo frequency, the price rise based on the stockpiling criterion may be greater than with no stockpiling. is then unwarranted.]

An embargo probability leads to private adjustments to curtail consumption and expand production, raising marginal value of consumption less than of production. If there are unemployment or foreign policy externalities, there is an optimal tariff which is proportional to foreign dependence, is inversely proportional to elasticity of external embargo loss, varies directly with embargo probability, and depends more complexly on other parameters. Stockpiling should limit embargo price rise to unit cost of storage divided by embargo frequency. With low embargo frequency, the price rise based on the stockpiling criterion may be greater than with no stockpiling. is then unwarranted.