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The optimum Quantity of Money with Borrowing Constraints

Author

Listed:
  • Francesco Lippi

    (University of Sassari and EIEF)

  • Nicholas Trachter

    (EIEF)

Abstract

We provide an analytical characterization of the optimal anticipated monetary policy in an economy where agents have a precautionary savings motive due to random production opportunities and the presence of borrowing constraints. Non storable production makes intrinsically useless outside money valuable to insure consumption. We show that the choice of the optimal money growth rate trades off insurance vs. incentives to produce: an expansionary policy provides liquidity to borrowing constrained agents, but distorts production incentives. The joint presence of uncertainty and borrowing constraints implies that the Friedman rule leads to autarkic allocations. If the utility function satisfies Inada conditions then the optimal money growth rate is strictly positive and finite.

Suggested Citation

  • Francesco Lippi & Nicholas Trachter, 2011. "The optimum Quantity of Money with Borrowing Constraints," EIEF Working Papers Series 1108, Einaudi Institute for Economics and Finance (EIEF), revised Apr 2011.
  • Handle: RePEc:eie:wpaper:1108
    as

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    References listed on IDEAS

    as
    1. Edward J. Green & Ruilin Zhou, 2005. "Money As A Mechanism In A Bewley Economy," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 46(2), pages 351-371, May.
    2. John Moore & Nobuhiro Kiyotaki, 2008. "Liquidity, Business Cycles, and Monetary Policy," 2008 Meeting Papers 35, Society for Economic Dynamics.
    3. Chris Edmond, 2002. "Self-Insurance, Social Insurance, and the Optimum Quantity of Money," American Economic Review, American Economic Association, pages 141-147.
    4. Timothy J. Kehoe & David K. Levine & Michael Woodford, 1990. "The optimum quantity of money revisited," Working Papers 404, Federal Reserve Bank of Minneapolis.
    5. Veronica Guerrieri & Guido Lorenzoni, 2009. "Liquidity and Trading Dynamics," Econometrica, Econometric Society, vol. 77(6), pages 1751-1790, November.
    6. Ahmet Akyol, 2000. "Optimal Monetary Policy in an Economy with Incomplete Markets and Idiosyncratic Shocks," Econometric Society World Congress 2000 Contributed Papers 0796, Econometric Society.
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