Inflation, Self Insurance and the Friedman Rule in Economies with Uninsurable Idiosyncratic Risks
The paper studies asset prices and capital accumulation in a monetary economy with non-diversifiable idiosyncratic risks. A government issued unbacked currency is introduced into agent's preferences in a dynamic GEI (General Equilibrium with Incomplete market) model with CARA preferences and normal disturbances. Closed form expressions for equilibrium allocations and prices are derived. The paper identifies two new channels through which money growth affects self insurance, interest rate and capital accumulation. The paper also shows that the resulting non-linearities in the relationships between the rate of inflation, the steady state capital stock and the interest rate, may even cause an optimal rate of inflation not to exist. Further, the Friedman rule is shown to be suboptimal for some economies.
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Volume (Year): 9 (2009)
Issue (Month): 1 (March)
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