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The optimum Quantity of Money with Borrowing Constraints

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Author Info

  • Francesco Lippi

    (University of Sassari and EIEF)

  • Nicholas Trachter

    (EIEF)

Abstract

We provide an analytical characterization of the optimal anticipated monetary policy in an economy where agents have a precautionary savings motive due to random production opportunities and the presence of borrowing constraints. Non storable production makes intrinsically useless outside money valuable to insure consumption. We show that the choice of the optimal money growth rate trades off insurance vs. incentives to produce: an expansionary policy provides liquidity to borrowing constrained agents, but distorts production incentives. The joint presence of uncertainty and borrowing constraints implies that the Friedman rule leads to autarkic allocations. If the utility function satisfies Inada conditions then the optimal money growth rate is strictly positive and finite.

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Bibliographic Info

Paper provided by Einaudi Institute for Economics and Finance (EIEF) in its series EIEF Working Papers Series with number 1108.

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Length: 40 pages
Date of creation: 2011
Date of revision: Apr 2011
Handle: RePEc:eie:wpaper:1108

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  1. Edward J. Green & Ruilin Zhou, 2002. "Money as a mechanism in a Bewley economy," Working Paper Series WP-02-15, Federal Reserve Bank of Chicago.
  2. Timothy J. Kehoe & David K. Levine & Michael Woodford, 1990. "The optimum quantity of money revisited," Working Papers 404, Federal Reserve Bank of Minneapolis.
  3. Nobuhiro Kiyotaki & John Moore, 2012. "Liquidity, Business Cycles, and Monetary Policy," NBER Working Papers 17934, National Bureau of Economic Research, Inc.
  4. Veronica Guerrieri & Guido Lorenzoni, 2007. "Liquidity and Trading Dynamics," NBER Working Papers 13204, National Bureau of Economic Research, Inc.
  5. Chris Edmond, 2002. "Self-Insurance, Social Insurance, and the Optimum Quantity of Money," American Economic Review, American Economic Association, vol. 92(2), pages 141-147, May.
  6. Ahmet Akyol, 2000. "Optimal Monetary Policy in an Economy with Incomplete Markets and Idiosyncratic Shocks," Econometric Society World Congress 2000 Contributed Papers 0796, Econometric Society.
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