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The liquidity trap, the real balance effect, and the Friedman rule

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  • Peter Ireland

Abstract

This paper studies the behavior of the economy and the efficacy of monetary policy under zero nominal interest rates, using a model with population growth that nests, as a special case, a more conventional specification in which there is a single infinitely lived representative agent. The paper shows that with a growing population, monetary policy has distributional effects that give rise to a real balance effect, thereby eliminating the liquidity trap. These same distributional effects, however, can also work to make many agents much worse off under zero nominal interest rates than they are when the nominal interest rate is positive.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Boston in its series Working Papers with number 05-3.

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Date of creation: 2005
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Handle: RePEc:fip:fedbwp:05-3

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Keywords: Monetary policy ; Price levels;

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  1. Svensson, Lars E O, 1999. "How Should Monetary Policy Be Conducted In An Era Of Price Stability?," CEPR Discussion Papers 2342, C.E.P.R. Discussion Papers.
  2. Barro, Robert J, 1974. "Are Government Bonds Net Wealth?," Journal of Political Economy, University of Chicago Press, vol. 82(6), pages 1095-1117, Nov.-Dec..
  3. Gahvari, Firouz, 1988. "Lump-sum taxation and the superneutrality and optimum quantity of money in life cycle growth models," Journal of Public Economics, Elsevier, vol. 36(3), pages 339-367, August.
  4. Bennett T. McCallum, 1986. "Some Issues Concerning Interest Rate Pegging, Price Level Determinacy, and the Real Bills Doctrine," NBER Working Papers 1294, National Bureau of Economic Research, Inc.
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  8. Freeman, Scott, 1985. "Transactions Costs and the Optimal Quantity of Money," Journal of Political Economy, University of Chicago Press, vol. 93(1), pages 146-57, February.
  9. Bhattacharya, Joydeep & Haslag, Joseph & Russell, Steven, 2004. "The Role of Money in Two Alternative Models: When is the Friedman Rule Optimal, and Why?," Staff General Research Papers 11950, Iowa State University, Department of Economics.
  10. Woodford, Michael, 1990. "The optimum quantity of money," Handbook of Monetary Economics, in: B. M. Friedman & F. H. Hahn (ed.), Handbook of Monetary Economics, edition 1, volume 2, chapter 20, pages 1067-1152 Elsevier.
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  12. Harold L. Cole & Narayana R. Kocherlakota, 1998. "Zero nominal interest rates: why they're good and how to get them," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Spr, pages 2-10.
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  14. Peter N. Ireland, 2000. "Implementing the Friedman Rule," Boston College Working Papers in Economics 460, Boston College Department of Economics.
  15. Olivier J. Blanchard, 1984. "Debt, Deficits and Finite Horizons," NBER Working Papers 1389, National Bureau of Economic Research, Inc.
  16. Woodford, Michael, 1994. "Monetary Policy and Price Level Determinacy in a Cash-in-Advance Economy," Economic Theory, Springer, vol. 4(3), pages 345-80.
  17. Thomas F. Cooley & Gary D. Hansen, 1987. "The Inflation Tax in a Real Business Cycle Model," UCLA Economics Working Papers 496, UCLA Department of Economics.
  18. Lucas, Robert E, Jr, 1980. "Equilibrium in a Pure Currency Economy," Economic Inquiry, Western Economic Association International, vol. 18(2), pages 203-20, April.
  19. Greenwood, Jeremy & Hercowitz, Zvi & Huffman, Gregory W, 1988. "Investment, Capacity Utilization, and the Real Business Cycle," American Economic Review, American Economic Association, vol. 78(3), pages 402-17, June.
  20. Cohen, Daniel, 1985. "Inflation, wealth and interest rates in an intertemporal optimizing model," Journal of Monetary Economics, Elsevier, vol. 16(1), pages 73-85, July.
  21. Paul R. Krugman, 1998. "It's Baaack: Japan's Slump and the Return of the Liquidity Trap," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 29(2), pages 137-206.
  22. Bruce D. Smith, 2002. "Monetary Policy, Banking Crises, and the Friedman Rule," American Economic Review, American Economic Association, vol. 92(2), pages 128-134, May.
  23. Freeman, Scott J, 1989. "Fiat Money as a Medium of Exchange," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 30(1), pages 137-51, February.
  24. Weiss, Laurence M, 1980. "The Effects of Money Supply on Economic Welfare in the Steady State," Econometrica, Econometric Society, vol. 48(3), pages 565-76, April.
  25. William C. Whitesell, 1988. "Age heterogeneity and the Tobin effect with infinite horizons," Finance and Economics Discussion Series 4, Board of Governors of the Federal Reserve System (U.S.).
  26. Michael Mussa, 2000. "Summary panel: reflections on monetary policy at low inflation," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, pages 1100-1106.
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Citations

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Cited by:
  1. Joydeep Bhattacharya & Joseph Haslag & Antoine Martin & Rajesh Singh, 2005. "Who is afraid of the Friedman rule?," Staff Reports 208, Federal Reserve Bank of New York.
  2. Firouz Gahvari, 2009. "Friedman Rule in a Model with Endogenous Growth and Cash-in-advance Constraint," CESifo Working Paper Series 2708, CESifo Group Munich.
  3. Araújo, Eurilton, 2008. "Robust Monetary Policy with the Consumption-Wealth Channel," Insper Working Papers wpe_110, Insper Working Paper, Insper Instituto de Ensino e Pesquisa.
  4. Barbara Annicchiarico & Giancarlo Marini & Alessandro Piergallini, 2009. "Wealth effects, the Taylor rule and the liquidity trap," International Journal of Economic Theory, The International Society for Economic Theory, vol. 5(3), pages 315-331.
  5. Peter Ireland, 2005. "EconomicDynamics Interviews Peter Ireland on Money and the Business Cycle," EconomicDynamics Newsletter, Review of Economic Dynamics, vol. 7(1), November.

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