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The optimum Quantity of Money with Borrowing Constraints

  • Francesco Lippi

    (University of Sassari and EIEF)

  • Nicholas Trachter

    (EIEF)

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.

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File URL: http://www.eief.it/files/2012/09/wp-08-the-optimum-quantity-of-money-with-borrowing-constraints.pdf
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Paper provided by Einaudi Institute for Economics and Finance (EIEF) in its series EIEF Working Papers Series with number 1108.

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Length: 40 pages
Date of creation: 2011
Date of revision: Apr 2011
Handle: RePEc:eie:wpaper:1108
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  1. Chris Edmond, 2002. "Self-Insurance, Social Insurance, and the Optimum Quantity of Money," American Economic Review, American Economic Association, vol. 92(2), pages 141-147, May.
  2. Nobuhiro Kiyotaki & John Moore, 2012. "Liquidity, Business Cycles and Monetary Policy," ESE Discussion Papers 113, Edinburgh School of Economics, University of Edinburgh.
  3. Timothy J. Kehoe & David K. Levine & Michael Woodford, 1990. "The optimum quantity of money revisited," Working Papers 404, Federal Reserve Bank of Minneapolis.
  4. 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, 05.
  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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