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State Dependent Monetary Policy

  • Francesco Lippi

    (University of Sassari and EIEF)

  • Stefania Ragni

    (University of Sassari)

  • Nicholas Trachter

    (EIEF)

We study the optimal anticipated monetary policy in a flexible-price economy featuring heterogenous agents and incomplete markets which give rise to a business cycle. The optimal policy prescribes monetary expansions in recessions, when insurance is most needed by cash-poor unproductive agents. To minimize the inflationary effect of these expansions the policy prescribes monetary contractions in good times. Although the optimal monetary policy varies greatly through the business cycle it "echoes" Friedman's principle in the sense that the money supply is regulated such that its expected real return approaches the rate of time preference.

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Paper provided by Einaudi Institute for Economics and Finance (EIEF) in its series EIEF Working Papers Series with number 1324.

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Length: 31 pages
Date of creation: 2013
Date of revision: Sep 2013
Handle: RePEc:eie:wpaper:1324
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