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State dependent monetary policy

  • Francesco Lippi
  • Stefania Ragni
  • Nicholas Trachter

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. In this setting money policy has distributional effects that depend on the state of the cycle. We parsimoniously characterize the dynamics of the economy and study the optimal regulation of the money supply as a function of the state. 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 money growth rate varies greatly through the business cycle, this policy "echoes" Friedman's principle in the sense that the expected real return of money approaches the rate of time preference.

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Paper provided by Federal Reserve Bank of Richmond in its series Working Paper with number 13-17.

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Date of creation: 2013
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Handle: RePEc:fip:fedrwp:13-17
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  1. Aleksander Berentsen & Gabriele Camera & C hristopher W aller, 2005. "The Distribution Of Money Balances And The Nonneutrality Of Money," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 46(2), pages 465-487, 05.
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  3. 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.
  4. Grossman, Sanford & Weiss, Laurence, 1983. "A Transactions-Based Model of the Monetary Transmission Mechanism," American Economic Review, American Economic Association, vol. 73(5), pages 871-80, December.
  5. Shouyong Shi, 1996. "A Divisible Search Model of Fiat Money," Working Papers 930, Queen's University, Department of Economics.
  6. Bhattacharya, Joydeep & Haslag, Joseph & Martin, Antoine, 2004. "Heterogeneity, Redistribution, and the Friedman Rule," Staff General Research Papers 11371, Iowa State University, Department of Economics.
  7. Miguel Molico, 2006. "The Distribution Of Money And Prices In Search Equilibrium," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 47(3), pages 701-722, 08.
  8. Neil Wallace, 1984. "Some of the choices for monetary policy," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win.
  9. Timothy J. Kehoe & David K. Levine & Michael Woodford, 1990. "The optimum quantity of money revisited," Working Papers 404, Federal Reserve Bank of Minneapolis.
  10. Shi, Shouyong, 1999. "Money, capital, and redistributive effects of monetary policies," Journal of Economic Dynamics and Control, Elsevier, vol. 23(4), pages 565-590, February.
  11. Veronica Guerrieri & Guido Lorenzoni, 2011. "Credit Crises, Precautionary Savings, and the Liquidity Trap," NBER Working Papers 17583, National Bureau of Economic Research, Inc.
  12. David K. Levine, 1991. "Asset Trading Mechanisms and Expansionary Policy," Levine's Working Paper Archive 43, David K. Levine.
  13. Andolfatto, David, 2013. "Incentive-feasible deflation," Journal of Monetary Economics, Elsevier, vol. 60(4), pages 383-390.
  14. Yann Algan & Edouard Challe & Xavier Ragot, 2008. "Incomplete markets and the output-inflation tradeoff," PSE Working Papers halshs-00589134, HAL.
  15. Scheinkman, Jose A & Weiss, Laurence, 1986. "Borrowing Constraints and Aggregate Economic Activity," Econometrica, Econometric Society, vol. 54(1), pages 23-45, January.
  16. Lucas, Robert Jr., 1990. "Liquidity and interest rates," Journal of Economic Theory, Elsevier, vol. 50(2), pages 237-264, April.
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