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Optimal monetary and fiscal policies in a search theoretic model of monetary exchange

  • Gomis-Porqueras, Pedro
  • Peralta-Alva, Adrian

Search models of monetary exchange commonly assume that terms of trade in anonymous markets are determined via Nash bargaining, which generally causes monetary equilibrium to be inefficient. Bargaining frictions add to the classical intertemporal distortion present in most monetary models, whereby agents work today to obtain cash that can be used only in future transactions. In this paper, we study the properties of optimal fiscal and monetary policy within the framework of Lagos and Wright (2005). We show that fiscal policy can be implemented to alleviate underproduction while money is still essential. If lump sum monetary transfers are available, a production subsidy can restore the efficiency of monetary equilibria. The Friedman rule belongs to the optimal policy set, but higher inflation rates are also possible. When lump-sum monetary transfers are not available, equilibrium allocations are generally not first-best. Nevertheless, fiscal policy still results in substantial welfare gains. Money can be extracted from circulation via a sales tax on decentralized market activities, and the Friedman rule is only optimal if the buyer has relatively low bargaining power.

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Article provided by Elsevier in its journal European Economic Review.

Volume (Year): 54 (2010)
Issue (Month): 3 (April)
Pages: 331-344

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Handle: RePEc:eee:eecrev:v:54:y:2010:i:3:p:331-344
Contact details of provider: Web page: http://www.elsevier.com/locate/eer

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  1. Andolfatto, David, 2008. "Essential Interest-Bearing Money (2008)," MPRA Paper 8565, University Library of Munich, Germany.
  2. Narayana R. Kocherlakota, 2005. "Optimal Monetary Policy: What We Know And What We Don'T Know," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 46(2), pages 715-729, 05.
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  4. Joydeep Bhattacharya & Joseph H. Haslag & Antoine Martin, 2004. "Heterogeneity, redistribution, and the Friedman rule," Research Working Paper RWP 04-01, Federal Reserve Bank of Kansas City.
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  8. Andolfatto, David, 2007. "Essential Interest-Bearing Money," MPRA Paper 4780, University Library of Munich, Germany.
  9. 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.
  10. 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.
  11. Randall Wright, 2005. "Introduction To "Models Of Monetary Economies Ii: The Next Generation"," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 46(2), pages 305-316, 05.
  12. Scott Freeman & Joseph H. Haslag, 1995. "Should bank reserves earn interest?," Economic and Financial Policy Review, Federal Reserve Bank of Dallas, issue Q IV, pages 25-33.
  13. Alberto Trejos & Randall Wright, 1993. "Search, bargaining, money and prices: recent results and policy implications," Proceedings, Federal Reserve Bank of Cleveland, pages 558-584.
  14. Boragan Aruoba, S. & Rocheteau, Guillaume & Waller, Christopher, 2007. "Bargaining and the value of money," Journal of Monetary Economics, Elsevier, vol. 54(8), pages 2636-2655, November.
  15. Kalai, Ehud & Smorodinsky, Meir, 1975. "Other Solutions to Nash's Bargaining Problem," Econometrica, Econometric Society, vol. 43(3), pages 513-18, May.
  16. Chae, Suchan, 2002. "Tax incidence with bargaining," Economics Letters, Elsevier, vol. 77(2), pages 199-204, October.
  17. 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.
  18. George S. Tolley, 1957. "Providing for Growth of the Money Supply," Journal of Political Economy, University of Chicago Press, vol. 65, pages 465.
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