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The role of money in two alternative models: When is the Friedman rule optimal, and why?

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  • Bhattacharya, Joydeep
  • Haslag, Joseph
  • Russell, Steven

Abstract

In models of money with an infinitely-lived representative agent (ILRA models), the optimal monetary policy is almost always the Friedman rule. Overlapping generations (OG) models are different: in this paper, we study how they are different, and why. We investigate the welfare properties of monetary policy in a simple OG model under two different types of money demand specifications and under two alternative assumptions about the generational timing of taxes for money retirement. We find that the Friedman rule is generally not the policy that maximizes steady-state utility. We conclude that the key difference between ILRA and OG monetary models is that in the latter, the standard method for constructing a monetary regime causes transactions involving money to become intergenerational transfers. Overlapping generations are different in this regard; we study how they are different and why.
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  • Bhattacharya, Joydeep & Haslag, Joseph & Russell, Steven, 2005. "The role of money in two alternative models: When is the Friedman rule optimal, and why?," Journal of Monetary Economics, Elsevier, vol. 52(8), pages 1401-1433, November.
  • Handle: RePEc:eee:moneco:v:52:y:2005:i:8:p:1401-1433
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    Cited by:

    1. Bhattacharya, Joydeep & Singh, Rajesh, 2008. "Optimal choice of monetary policy instruments in an economy with real and liquidity shocks," Journal of Economic Dynamics and Control, Elsevier, vol. 32(4), pages 1273-1311, April.
    2. Schnell, Fabian, 2013. "Can Monetary Policy Delay the Reallocation of Capital?," Economics Working Paper Series 1329, University of St. Gallen, School of Economics and Political Science.
    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, vol. 46(4), pages 1271-1301, November.
    4. 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, vol. 46(2), pages 437-454, May.
    5. Machicado, Carlos Gustavo, 2008. "Liquidity shocks and the dollarization of a banking system," Journal of Macroeconomics, Elsevier, pages 369-381.
    6. Peter Ireland, 2005. "EconomicDynamics Interviews Peter Ireland on Money and the Business Cycle," EconomicDynamics Newsletter, Review of Economic Dynamics.
    7. Angus C. Chu & Guido Cozzi, 2014. "R&D And Economic Growth In A Cash‐In‐Advance Economy," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 55, pages 507-524, May.
    8. Alexandre Cunha, 2008. "The optimality of the Friedman rule when some distorting taxes are exogenous," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), pages 267-291.
    9. Homburg Stefan, 2015. "Superneutrality of Money under Open Market Operations," Review of Economics, De Gruyter, pages 289-302.
    10. Berentsen, Aleksander & Strub, Carlo, 2009. "Central bank design with heterogeneous agents," European Economic Review, Elsevier, vol. 53(2), pages 139-152, February.
    11. Arbex, Marcelo & Turdaliev, Nurlan, 2011. "Optimal monetary and audit policy with imperfect taxation," Journal of Macroeconomics, Elsevier, pages 327-340.
    12. Firouz Gahvari, 2009. "Friedman Rule in a Model with Endogenous Growth and Cash-in-advance Constraint," CESifo Working Paper Series 2708, CESifo Group Munich.
    13. Cyril Monnet & William Roberds, 2006. "Credit and the no-surcharge rule," FRB Atlanta Working Paper 2006-25, Federal Reserve Bank of Atlanta.
    14. Carlos Gustavo Machicado, 2007. "Growth and Banking Structure in a Partially Dollarized Economy," Development Research Working Paper Series 02/2007, Institute for Advanced Development Studies.
    15. Partha Sen, 2005. "Debt Policy in a Competitive Two-Sector Overlapping Generations Model," Working papers 137, Centre for Development Economics, Delhi School of Economics.
    16. Bhattacharya, Joydeep & Singh, Rajesh, 2006. "On the Usefulness of the Constrained Planning Problem in a Model of Money," Staff General Research Papers Archive 12660, Iowa State University, Department of Economics.
    17. Gahvari, Firouz, 2007. "The Friedman rule: Old and new," Journal of Monetary Economics, Elsevier, vol. 54(2), pages 581-589, March.
    18. Yanagihara, Mitsuyoshi & Lu, Chen, 2013. "Cash-in-advance constraint, optimal monetary policy, and human capital accumulation," Research in Economics, Elsevier, pages 278-288.
    19. Gomme, Paul, 2015. "Measuring the welfare costs of inflation in a life-cycle model," Journal of Economic Dynamics and Control, Elsevier, pages 132-144.
    20. Takemasa Oda, 2016. "Optimal Inflation Rate in a Life-Cycle Economy," IMES Discussion Paper Series 16-E-05, Institute for Monetary and Economic Studies, Bank of Japan.
    21. Homburg, Stefan, 2017. "A Study in Monetary Macroeconomics," OUP Catalogue, Oxford University Press, number 9780198807537.
    22. Ben Lockwood & Erez Yerushalmi, 2014. "Should transactions services be taxed at the same rate as consumption?," Working Papers 1423, Oxford University Centre for Business Taxation.
    23. Bhattacharya, Joydeep & Singh, Rajesh, 2005. "Optimal Choice of Monetary Instruments in an Economy with Real and Liquidity Shocks," Staff General Research Papers Archive 12355, Iowa State University, Department of Economics.
    24. repec:bpj:bejtec:v:17:y:2017:i:2:p:14:n:5 is not listed on IDEAS

    More about this item

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy

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