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Who is Afraid of the Friedman Rule?

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  • Bhattacharya, Joydeep
  • Haslag, Joseph
  • Martin, Antoine
  • Singh, Rajesh

Abstract

In this paper, we explore the connection between optimal monetary policy and heterogeneity among agents. We study a standard monetary economy with two types of agents in which the stationary distribution of money holdings is non-degenerate. Sans type-specific fiscal policy, we show that the zero-nominal-interest rate policy (the Friedman rule) does not maximize type-specific welfare; it may not maximize aggregate social welfare either. Indeed, one or, more surprisingly, both types may benefit if the central bank deviates from the Friedman rule. Our results suggest a positive explanation for why central banks around the world do not implement the Friedman rule.

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File URL: http://www.econ.iastate.edu/sites/default/files/publications/papers/p1852-2004-11-10.pdf
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Bibliographic Info

Paper provided by Iowa State University, Department of Economics in its series Staff General Research Papers with number 12213.

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Date of creation: 10 Nov 2004
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Publication status: Published in Economic Inquiry, April 2008, vol. 46 no. 2, pp. 113-130
Handle: RePEc:isu:genres:12213

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Postal: Iowa State University, Dept. of Economics, 260 Heady Hall, Ames, IA 50011-1070
Phone: +1 515.294.6741
Fax: +1 515.294.0221
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Web page: http://www.econ.iastate.edu
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Keywords: Friedman rule; monetary policy; money-in-the-utility-function;

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References

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  1. 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, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 46(2), pages 437-454, 05.
  2. Chris Edmond, 2002. "Self-Insurance, Social Insurance, and the Optimum Quantity of Money," American Economic Review, American Economic Association, American Economic Association, vol. 92(2), pages 141-147, May.
  3. Peter N. Ireland, 2005. "The Liquidity Trap, The Real Balance Effect, And The Friedman Rule ," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 46(4), pages 1271-1301, November.
  4. Beatrix Paal & Bruce D. Smith, 2001. "The sub-optimality of the Friedman rule and the optimum quantity of money," IEHAS Discussion Papers, Institute of Economics, Centre for Economic and Regional Studies, Hungarian Academy of Sciences 0113, Institute of Economics, Centre for Economic and Regional Studies, Hungarian Academy of Sciences.
  5. V. V. Chari & Lawrence J. Christiano & Patrick J. Kehoe, 1993. "Optimality of the Friedman Rule in Economies with Distorting Taxes," NBER Working Papers 4443, National Bureau of Economic Research, Inc.
  6. Carlos E. da Costa & Iván Werning, 2008. "On the Optimality of the Friedman Rule with Heterogeneous Agents and Nonlinear Income Taxation," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 116(1), pages 82-112, 02.
  7. Feenstra, Robert C., 1986. "Functional equivalence between liquidity costs and the utility of money," Journal of Monetary Economics, Elsevier, Elsevier, vol. 17(2), pages 271-291, March.
  8. David K. Levine, 1991. "Asset Trading Mechanisms and Expansionary Policy," Levine's Working Paper Archive 43, David K. Levine.
  9. Correia, Isabel & Teles, Pedro, 1996. "Is the Friedman rule optimal when money is an intermediate good?," Journal of Monetary Economics, Elsevier, Elsevier, vol. 38(2), pages 223-244, October.
  10. Andrés Erosa & Gustavo Ventura, 2000. "On Inflation as a Regressive Consumption Tax," UWO Department of Economics Working Papers, University of Western Ontario, Department of Economics 20001, University of Western Ontario, Department of Economics.
  11. Albanesi, Stefania, 2003. "Optimal and Time-Consistent Monetary and Fiscal Policy with Heterogeneous Agents," CEPR Discussion Papers, C.E.P.R. Discussion Papers 3713, C.E.P.R. Discussion Papers.
  12. Edward J. Green & Ruilin Zhou, 2002. "Money as a mechanism in a Bewley economy," Working Paper Series, Federal Reserve Bank of Chicago WP-02-15, Federal Reserve Bank of Chicago.
  13. Greenwood, Jeremy & Hercowitz, Zvi & Huffman, Gregory W, 1988. "Investment, Capacity Utilization, and the Real Business Cycle," American Economic Review, American Economic Association, American Economic Association, vol. 78(3), pages 402-17, June.
  14. Gahvari, Firouz, 1988. "Lump-sum taxation and the superneutrality and optimum quantity of money in life cycle growth models," Journal of Public Economics, Elsevier, Elsevier, vol. 36(3), pages 339-367, August.
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Cited by:
  1. Sofía Bauducco, 2011. "Seigniorage and Distortionary Taxation in a Model with Heterogeneous Agents and Idiosyncratic Uncertainty," Working Papers Central Bank of Chile, Central Bank of Chile 611, Central Bank of Chile.
  2. Andolfatto, David, 2013. "Incentive-feasible deflation," Journal of Monetary Economics, Elsevier, Elsevier, vol. 60(4), pages 383-390.

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