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Incentives and the Limits to Deflationary Policy

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Abstract

I study a version of the Lagos-Wright (2005) model for which the Friedman rule is always a desirable policy, but where implementation may be constrained by the need to respect incentive-feasibility. In the environment I consider, incentives are distorted owing to private information and limited commitment. I demonstrate that a monetary economy can overcome the former friction, but not necessarily the latter. When this is so, there is an incentive-induced lower bound to the rate of deflation away from the Friedman rule. There are also circumstances in which the best incentive-feasible monetary policy may entail a strictly positive rate of inflation. This will be the case, for example, if agents are sufficiently impatient or if there are rapidly diminishing returns to production.

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File URL: http://www.sfu.ca/econ-research/RePEc/sfu/sfudps/dp07-14.pdf
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Bibliographic Info

Paper provided by Department of Economics, Simon Fraser University in its series Discussion Papers with number dp07-14.

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Length: 20 pages
Date of creation: 2007
Date of revision:
Handle: RePEc:sfu:sfudps:dp07-14

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Postal: Department of Economics, Simon Fraser University, 8888 University Drive, Burnaby, BC, V5A 1S6, Canada
Phone: (778)782-3508
Fax: (778)782-5944
Web page: http://www.sfu.ca/economics.html
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Postal: Working Paper Coordinator, Department of Economics, Simon Fraser University, 8888 University Drive, Burnaby, BC, V5A 1S6, Canada
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Web: http://www.sfu.ca/economics/research/publications.html

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  1. Tai-wei Hu & John Kennan & Neil Wallace, 2009. "Coalition-Proof Trade and the Friedman Rule in the Lagos-Wright Model," Journal of Political Economy, University of Chicago Press, vol. 117(1), pages 116-137, 02.
  2. Guillaume Rocheteau & Randall Wright, 2003. "Money in Search Equilibrium, in Competitive Equilibrium, and in Competitive Search Equilibrium," PIER Working Paper Archive 03-031, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
  3. Ricardo Lagos & Guillaume Rocheteau, 2004. "Inflation, output and welfare," Staff Report 342, Federal Reserve Bank of Minneapolis.
  4. Levine, David K., 1991. "Asset trading mechanisms and expansionary policy," Journal of Economic Theory, Elsevier, vol. 54(1), pages 148-164, June.
  5. 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.
  6. 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.
  7. Kocherlakota, Narayana R., 1998. "Money Is Memory," Journal of Economic Theory, Elsevier, vol. 81(2), pages 232-251, August.
  8. Shouyong Shi, 1996. "A Divisible Search Model of Fiat Money," Working Papers 930, Queen's University, Department of Economics.
  9. Kiyotaki, Nobuhiro & Wright, Randall, 1989. "On Money as a Medium of Exchange," Journal of Political Economy, University of Chicago Press, vol. 97(4), pages 927-54, August.
  10. University of Notre Dame & Christopher Waller, 2008. "Dynamic Taxation, Private Information and Money," 2008 Meeting Papers 896, Society for Economic Dynamics.
  11. Stephen Williamson, 2004. "Search, Limited Participation, and Monetary Policy," 2004 Meeting Papers 214, Society for Economic Dynamics.
  12. Narayana Kocherlakota, 2002. "The Two-Money Theorem," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 43(2), pages 333-346, May.
  13. Miguel Molico, 2006. "The Distribution Of Money And Prices In Search Equilibrium," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 47(3), pages 701-722, 08.
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Citations

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Cited by:
  1. Gaetano Antinolfi & Costas Azariadis & James B. Bullard, 2007. "The optimal inflation target in an economy with limited enforcement," Working Papers 2007-037, Federal Reserve Bank of St. Louis.
  2. David Andolfatto, 2009. "Essential interest-bearing money," Working Papers 2009-044, Federal Reserve Bank of St. Louis.
  3. Williamson, Stephen & Sanches, Daniel, 2009. "Money and Credit With Limited Commitment and Theft," MPRA Paper 20690, University Library of Munich, Germany.
  4. Berentsen, Aleksander & Monnet, Cyril, 2008. "Monetary policy in a channel system," Journal of Monetary Economics, Elsevier, vol. 55(6), pages 1067-1080, September.
  5. Guillaume Rocheteau, 2008. "Money and competing assets under private information," Working Paper 0802, Federal Reserve Bank of Cleveland.
  6. Alessandro Marchesiani & Aleksander Berentsen, 2010. "Standing Facilities Versus Open Market Operations: Equivalence Results," 2010 Meeting Papers 929, Society for Economic Dynamics.
  7. Guillaume Rocheteau, 2009. "A monetary approach to asset liquidity," Working Paper 0901, Federal Reserve Bank of Cleveland.

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