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Understanding the Roles of Money, or When is the Friedman Rule Optimal, and Why?

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Abstract

In this paper, we study the optimal steady state monetary policy in overlapping generations (OG) models. In contrast to economies populated by inthnitely-lived representative agents (ILRA), the Friedman Rule is frequently not the policy that maximizes the welfare of two-period lived consumers. Our principal goal is to understand why the Friedman Rule is suboptimal in OG economies. To this end, we construct a mechanism.specithcally, a monetary policy regime.that renders money useless in the sense of executing intergenerational transfers. Under this governmental regime, we show that the optimal monetary policy is the Friedman Rule. Our thnding is robust to alternative rationales for valued that money; specithcally, whether money is held voluntarily or involuntarily.

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File URL: http://economics.missouri.edu/working-papers/2003/wp0301_haslag.pdf
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Bibliographic Info

Paper provided by Department of Economics, University of Missouri in its series Working Papers with number 0301.

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Length: 52 pgs.
Date of creation: 08 Jan 2003
Date of revision:
Handle: RePEc:umc:wpaper:0301

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Keywords: Monetary Policy; Friedman Rule; Fiat Money;

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References

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  1. Freeman, Scott, 1987. "Reserve requirements and optimal seigniorage," Journal of Monetary Economics, Elsevier, vol. 19(2), pages 307-314, March.
  2. King, Robert G., 1988. "Money demand in the United States: A quantitative review," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 29(1), pages 169-172, January.
  3. 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.
  4. Smith, B.D., 1988. "Interest On Reserves And Sunspot Equilibria: Friedman'S Proposal Reconsidered," RCER Working Papers 119, University of Rochester - Center for Economic Research (RCER).
  5. Bullard, James & Russell, Steven, 1999. "An empirically plausible model of low real interest rates and unbacked government debt," Journal of Monetary Economics, Elsevier, vol. 44(3), pages 477-508, December.
  6. Grandmont, Jean-Michel & Younes, Yves, 1973. "On the Efficiency of a Monetary Equilibrium," Review of Economic Studies, Wiley Blackwell, vol. 40(2), pages 149-65, April.
  7. Beatrix Paal & Bruce D. Smith, 2013. "The sub-optimality of the Friedman rule and the optimum quantity of money," Annals of Economics and Finance, Society for AEF, vol. 14(2), pages 911-948, November.
  8. Correia, Isabel & Teles, Pedro, 1996. "Is the Friedman rule optimal when money is an intermediate good?," Journal of Monetary Economics, Elsevier, vol. 38(2), pages 223-244, October.
  9. Sargent, Thomas & Wallace, Neil, 1985. "Interest on reserves," Journal of Monetary Economics, Elsevier, vol. 15(3), pages 279-290, May.
  10. Ireland, Peter N, 1996. "The Role of Countercyclical Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 104(4), pages 704-23, August.
  11. Joydeep Bhattacharya & Joseph H. Haslag, 2001. "On the Use of the Inflation Tax When Nondistortionary Taxes Are Available," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 4(4), pages 823-841, October.
  12. 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.
  13. Stephen D. Williamson, 1994. "Sequential markets and the suboptimality of the Friedman rule," Proceedings, Federal Reserve Bank of Dallas, issue Apr.
  14. David Cass & Menahem E. Yaari, 1966. "A Re-examination of the Pure Consumption Loans Model," Journal of Political Economy, University of Chicago Press, vol. 74, pages 353.
  15. Bencivenga, Valerie R & Smith, Bruce D, 1991. "Financial Intermediation and Endogenous Growth," Review of Economic Studies, Wiley Blackwell, vol. 58(2), pages 195-209, April.
  16. Kimbrough, Kent P., 1986. "The optimum quantity of money rule in the theory of public finance," Journal of Monetary Economics, Elsevier, vol. 18(3), pages 277-284, November.
  17. Lucas, Robert E., 1988. "Money demand in the United States: A quantitative review," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 29(1), pages 137-167, January.
  18. Helpman, Elhanan & Sadka, Efraim, 1979. "Optimal Financing of the Government's Budget: Taxes, Bonds, or Money?," American Economic Review, American Economic Association, vol. 69(1), pages 152-60, March.
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Cited by:
  1. Joseph H. Haslag & Joydeep Bhattacharya & Antoine Martin, 2004. "Sub-Optimality of the Friedman Rule in Townsends Turnpike and Limited Communication Models of money: Do finite lives and initial dates matter?," Working Papers 0415, Department of Economics, University of Missouri, revised 21 Dec 2004.
  2. Bhattacharya, Joydeep & Haslag, Joseph & Martin, Antoine, 2009. "Optimal monetary policy and economic growth," European Economic Review, Elsevier, vol. 53(2), pages 210-221, February.
  3. Bhattacharya, Joydeep & Haslag, Joseph & Martin, Antoine, 2004. "Heterogeneity, Redistribution, and the Friedman Rule," Staff General Research Papers 11371, Iowa State University, Department of Economics.
  4. Bhattacharya, Joydeep & Haslag, Joseph H. & Martin, Antoine, 2006. "Sub-optimality of the Friedman rule in Townsend's turnpike and stochastic relocation models of money: Do finite lives and initial dates matter?," Journal of Economic Dynamics and Control, Elsevier, vol. 30(5), pages 879-897, May.
  5. Joydeep Bhattacharya & Joseph Haslag & Antoine Martin, 2005. "The Tobin effect and the Friedman rule," Staff Reports 224, Federal Reserve Bank of New York.

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