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Optimal Monetary Policy in an Economy with Incomplete Markets and Idiosyncratic Shocks

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  • Ahmet Akyol

    (University of Iowa)

Abstract

This study investigates an incomplete markets economy in which the saving behavior of a continuum of infinitely lived agents is influenced by precautionary saving motives and borrowing constraints. Two types of assets (interest bearing IOUs and money) enhance the liquidity of agents by providing an additional means of smoothing consumption and by effectively loosening borrowing constraints. Money is valued because of a timing friction in the bond market. In particular, the bond market closes before agents observe their idiosyncratic productivity shock. High inflation rates will transfer resources from agents with high endowments to those holding bonds which can increase welfare. However, in an inflationary environment, agents economize on money holdings, causing a reduction in welfare. Furthermore, different monetary growth rates will imply different seigniorage revenues for government. The level of seigniorage revenues will determine the interest rate on government bonds, and the effective borrowing constraint. This study quantitatively examines the welfare implications of different monetary growth rates. Initial results indicate that higher inflation rates increase welfare.

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Bibliographic Info

Paper provided by Econometric Society in its series Econometric Society World Congress 2000 Contributed Papers with number 0796.

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Date of creation: 01 Aug 2000
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Handle: RePEc:ecm:wc2000:0796

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  1. Thomas J. Sargent & Neil Wallace, 1981. "Some unpleasant monetarist arithmetic," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall.
  2. Per Krusell & Anthony A. Smith, Jr., . "On the Welfare Effects of Eliminating Business Cycles," GSIA Working Papers 243, Carnegie Mellon University, Tepper School of Business.
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Cited by:
  1. Nils Gornemann & Keith Kuester & Makoto Nakajima, 2012. "Monetary policy with heterogeneous agents," Working Papers 12-21, Federal Reserve Bank of Philadelphia.
  2. Francesco Lippi & Nicholas Trachter, 2011. "The optimum Quantity of Money with Borrowing Constraints," EIEF Working Papers Series 1108, Einaudi Institute for Economics and Finance (EIEF), revised Apr 2011.
  3. Claudio Campanale & Carolina Fugazza & Francisco Gomes, 2012. "Life-Cycle Portfolio Choice with Liquid and Illiquid Financial Assets," Carlo Alberto Notebooks 269, Collegio Carlo Alberto.
  4. Lizarazo, Sandra & Da-Rocha, Jose-Maria, 2011. "Optimal monetary policy and default," MPRA Paper 31931, University Library of Munich, Germany.

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