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Optimality of the Friedman rule in overlapping generations model with spatial separation

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  • Joseph H. Haslag
  • Antoine Martin

Abstract

Recent papers suggest that when intermediation is analyzed seriously, the Friedman rule does not maximize social welfare in overlapping generations model in which money is valued because of spatial separation and limited communication. These papers emphasize a trade-off between productive efficiency and risk sharing. We show financial intermediation or a trade-off between productive efficiency and risk sharing are neither necessary nor sufficient for that result. We give conditions under which the Friedman rule maximizes social welfare and show any feasible allocation such that money grows faster than the Friedman rule is Pareto dominated by a feasible allocation with the Friedman rule. The key to the results is the ability to make intergenerational transfers.

Suggested Citation

  • Joseph H. Haslag & Antoine Martin, 2003. "Optimality of the Friedman rule in overlapping generations model with spatial separation," Research Working Paper RWP 03-03, Federal Reserve Bank of Kansas City.
  • Handle: RePEc:fip:fedkrw:rwp03-03
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    References listed on IDEAS

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    1. Valerie R. Bencivenga & Bruce D. Smith, 1991. "Financial Intermediation and Endogenous Growth," Review of Economic Studies, Oxford University Press, vol. 58(2), pages 195-209.
    2. Beatrix Paal & Bruce D. Smith, 2013. "The sub-optimality of the Friedman rule and the optimum quantity of money," Annals of Economics and Finance, Society for AEF, vol. 14(2), pages 911-948, November.
    3. Freeman, Scott, 1993. "Resolving Differences over the Optimal Quantity of Money," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 25(4), pages 801-811, November.
    4. Stacey L. Schreft & Bruce D. Smith, 2002. "The conduct of monetary policy with a shrinking stock of government debt," Proceedings, Federal Reserve Bank of Cleveland, pages 848-886.
    5. Chari, V. V. & Christiano, Lawrence J. & Kehoe, Patrick J., 1996. "Optimality of the Friedman rule in economies with distorting taxes," Journal of Monetary Economics, Elsevier, vol. 37(2-3), pages 203-223, April.
    6. Kimbrough, Kent P., 1986. "The optimum quantity of money rule in the theory of public finance," Journal of Monetary Economics, Elsevier, vol. 18(3), pages 277-284, November.
    7. Correia, Isabel & Teles, Pedro, 1996. "Is the Friedman rule optimal when money is an intermediate good?," Journal of Monetary Economics, Elsevier, vol. 38(2), pages 223-244, October.
    8. Stacey Schreft & Bruce Smith, 2008. "The social value of risk-free government debt," Annals of Finance, Springer, vol. 4(2), pages 131-155, March.
    9. Joydeep Bhattacharya & Mark G. Guzman & Elisabeth Huybens & Bruce D. Smith, 1995. "Monetary, Fiscal, and Bank Regulatory Policy in a Simple Monetary Growth Model," Working Papers 9501, Centro de Investigacion Economica, ITAM.
    10. Bruce D. Smith, 2002. "Monetary Policy, Banking Crises, and the Friedman Rule," American Economic Review, American Economic Association, vol. 92(2), pages 128-134, May.
    11. Bruce D. Smith, 2003. "Taking intermediation seriously," Proceedings, Federal Reserve Bank of Cleveland, pages 1319-1377.
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    Cited by:

    1. Bhattacharya, Joydeep & Haslag, Joseph H. & Martin, Antoine, 2006. "Sub-optimality of the Friedman rule in Townsend's turnpike and stochastic relocation models of money: Do finite lives and initial dates matter?," Journal of Economic Dynamics and Control, Elsevier, vol. 30(5), pages 879-897, May.
    2. 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.
    3. 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.
    4. 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.
    5. 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.
    6. Machicado, Carlos Gustavo, 2008. "Liquidity shocks and the dollarization of a banking system," Journal of Macroeconomics, Elsevier, vol. 30(1), pages 369-381, March.
    7. A. Berentsen & C. Strub, 2004. "On the Friedman Rule with Heterogeneous Agents," Econometric Society 2004 Far Eastern Meetings 609, Econometric Society.
    8. Joseph H. Haslag & Joydeep Bhattacharya & Antoine Martin, 2004. "Sub-Optimality of the Friedman Rule in Townsends Turnpike and Limited Communication Models of money: Do finite lives and initial dates matter?," Working Papers 0415, Department of Economics, University of Missouri, revised 21 Dec 2004.
    9. Jung, Kuk Mo, 2018. "Uncertainty-induced dynamic inefficiency and the optimal inflation rate," International Review of Economics & Finance, Elsevier, vol. 56(C), pages 486-506.
    10. 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.

    More about this item

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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