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The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent.

This paper develops a full�employment theory of the business cycle in the context of a simple equilib rium dynamic monetary model with complete info:r:mation, overlapping genemtioll5 and production proceaacs. Thin theory is founded on three basic notions: (a.) economic agents plan to limit their own freedom of action; (b) it takes time to produce one unit of output; the pro ductive input can be employed on alternative discrete overla.pping production processes at each point in time. According to this theory, fully anticipated monetary shocks caUBe the mnd of movements in outputa, prices and nominal incomes , which are well known as the business cyde. *1 would like to express my gratitude to two special friends, Professors Gercldo da Silva e Souza. and Keti Tenenblat, of the University of Bra.ru1ia. Over a. time span of two years they frequently interrupted their nonnal research and teaching activities in the fields of statistics and mathematics in order to dedicate much time and patience to discuss many aspects of thio paper with me. Without. their help, it would have been much more difficult to bring this vernian to light. I am also grateful for t�e helpful suggestions of the referees of this Journal

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SurmlrioEste trabalho desenvolve uma teoria simples de determinac;:ao de renda e juros nomina is sob tres pressupostos principais. Em primeiro lugar, a unica distin�o relevante entre a rnoeda e titulos do governo reside nos prazos de retenc;:ap. Segundo, as indivfduos levam em conta a restriyao do on;:amento publico, nao se preocupando em descontar futuras obrigac;:5es fiscais aS$).Ciadas a emissao de titulos do governo. Finalmente, 0 modelo incornora urn mercado de enid ito privado para emprestimos e tom ada de emprestimos para e pelos indivfduos. De acordo com esta teoria, a ta'xa nominal de juros e determinada por dais fatores distintos: a relac;:ao titulo/maeda, e a taxa de expansao da base monetaria.A prime ira destas influencias pode gerar uma correlat;:ao positiva entre taxas nominais de juros e n(veis de pret;:os; a segunda pode levar a uma relac;:ao Intima entre 0 nlvel destas taxas nominais e as taxas de expansao do n(vel de prec;:os. Portanto, esta teoria aplica-se, de manei ra coerente, tanto ao Paradoxo Gibson como ao efeito Fisher. AbstractThis paper develops a simple theory of nominal j ' ncome interest determination under .three key assumptions: firstly, the only relevant distinction between money and government bonds. lies in their holding periods. Secondly, individuals take full account of the government budget cOl")straint and do not concern themselves with di scounting future tax liabilities associated with the issue of govern ment bonds. Finally, the model incorporates a private credit market for individuals' borrowings and lendings. According to this theory, the nominal rate of interest is determined by two separable influences, * A previous version of this paper was presented at the 7 t h Latin American Meeting of the Econometr;1c Society, Sao Paulo, August 4/7. 1987. * .. Senado Federal. R. de EconometriaRio de Janeiro v. VIII, n. 1, p. 7-20 jan./jun. 1988 the bond/money ratio and the rate of expansion of the money supply.The first of these influences can give rise to a positive correlation between nominal interest rates and price levels and the second can generate a close relationship between the level of these nominal rate and the rates of expansion of the price level. Therefore, this theory coherently accounts for both the Gibson Paradox and the Fisher· ·effect.