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Optimal monetary and fiscal policies in a search theoretic model of monetary exchange

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  • Gomis-Porqueras, Pedro
  • Peralta-Alva, Adrian

Abstract

Search models of monetary exchange commonly assume that terms of trade in anonymous markets are determined via Nash bargaining, which generally causes monetary equilibrium to be inefficient. Bargaining frictions add to the classical intertemporal distortion present in most monetary models, whereby agents work today to obtain cash that can be used only in future transactions. In this paper, we study the properties of optimal fiscal and monetary policy within the framework of Lagos and Wright (2005). We show that fiscal policy can be implemented to alleviate underproduction while money is still essential. If lump sum monetary transfers are available, a production subsidy can restore the efficiency of monetary equilibria. The Friedman rule belongs to the optimal policy set, but higher inflation rates are also possible. When lump-sum monetary transfers are not available, equilibrium allocations are generally not first-best. Nevertheless, fiscal policy still results in substantial welfare gains. Money can be extracted from circulation via a sales tax on decentralized market activities, and the Friedman rule is only optimal if the buyer has relatively low bargaining power.

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Bibliographic Info

Article provided by Elsevier in its journal European Economic Review.

Volume (Year): 54 (2010)
Issue (Month): 3 (April)
Pages: 331-344

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Handle: RePEc:eee:eecrev:v:54:y:2010:i:3:p:331-344

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Web page: http://www.elsevier.com/locate/eer

Related research

Keywords: Money Bargaining Search Inflation Fiscal policy;

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References

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  7. Ricardo Lagos & Randall Wright, 2005. "A Unified Framework for Monetary Theory and Policy Analysis," Journal of Political Economy, University of Chicago Press, vol. 113(3), pages 463-484, June.
  8. Randall Wright, 2005. "Introduction to "Models of Monetary Economies II: The Next Generation"," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Oct, pages 2-9.
  9. Ritter Moritz, 2010. "The Optimum Quantity of Money Revisited: Distortionary Taxation in a Search Model of Money," The B.E. Journal of Macroeconomics, De Gruyter, vol. 10(1), pages 1-26, June.
  10. Scott Freeman & Joseph H. Haslag, 1995. "Should bank reserves earn interest?," Economic and Financial Policy Review, Federal Reserve Bank of Dallas, issue Q IV, pages 25-33.
  11. Tai-wei Hu & John Kennan & Neil Wallace, 2007. "Coalition-Proof Trade and the Friedman Rule in the Lagos-Wright Model," NBER Working Papers 13310, National Bureau of Economic Research, Inc.
  12. Andolfatto, David, 2008. "Essential Interest-Bearing Money (2008)," MPRA Paper 8565, University Library of Munich, Germany.
  13. Chae, Suchan, 2002. "Tax incidence with bargaining," Economics Letters, Elsevier, vol. 77(2), pages 199-204, October.
  14. Narayana R. Kocherlakota, 2005. "Optimal monetary policy: what we know and what we don’t know," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Oct, pages 10-19.
  15. Kalai, Ehud & Smorodinsky, Meir, 1975. "Other Solutions to Nash's Bargaining Problem," Econometrica, Econometric Society, vol. 43(3), pages 513-18, May.
  16. Joydeep Bhattacharya & Joseph H. Haslag & Antoine Martin, 2005. "Heterogeneity, Redistribution, And The Friedman Rule," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 46(2), pages 437-454, 05.
  17. George S. Tolley, 1957. "Providing for Growth of the Money Supply," Journal of Political Economy, University of Chicago Press, vol. 65, pages 465.
  18. Deviatov Alexei & Wallace Neil, 2001. "Another Example in which Lump-sum Money Creation is Beneficial," The B.E. Journal of Macroeconomics, De Gruyter, vol. 1(1), pages 1-22, February.
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Citations

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Cited by:
  1. Nicolas L. Jacquet & Serene Tan, 2011. "Money, Bargaining, and Risk Sharing," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 43, pages 419-442, October.
  2. Moritz Ritter, 2010. "The Optimum Quantity of Money Revisited: Distortionary Taxation in a Search Model of Money," DETU Working Papers 1005, Department of Economics, Temple University.
  3. Pedro Gomis-Porqueras & Daniel R. Sanches, 2011. "Optimal monetary policy in a model of money and credit," Working Papers 11-28, Federal Reserve Bank of Philadelphia.
  4. Pedro Gomis-Porqueras & Benoit Julien & Chengsi Wang, 2010. "Optimal Monetary and Fiscal Policies in a Search-Theoretic Model of Money and Unemployment," Discussion Papers 2010-23, School of Economics, The University of New South Wales.
  5. Stephen D. Williamson & Randall Wright, 2010. "New Monetarist Economics: models," Staff Report 443, Federal Reserve Bank of Minneapolis.
  6. Fernando M. Martin, 2013. "Government Policy In Monetary Economies," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 54(1), pages 185-217, 02.
  7. Tao Peng, 2012. "A Note on the implementation of the Pareto efficient allocation in the Lagos-Wright model," Economics Bulletin, AccessEcon, vol. 32(1), pages 27-36.
  8. Christopher J. Waller, 2009. "Dynamic taxation, private information and money," Working Papers 2009-035, Federal Reserve Bank of St. Louis.
  9. Begoña Dominguez & Pedro Gomis-Porqueras, 2012. "On the Time Inconsistency of Optimal Monetary and Fiscal Policies With Many Consumer Goods," Development Research Unit Working Paper Series 31-12, Monash University, Department of Economics.

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