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Incentives and the Limits to Deflationary Policy

I study a version of the Lagos-Wright (2005) model for which the Friedman rule is always a desirable policy, but where implementation may be constrained by the need to respect incentive-feasibility. In the environment I consider, incentives are distorted owing to private information and limited commitment. I demonstrate that a monetary economy can overcome the former friction, but not necessarily the latter. When this is so, there is an incentive-induced lower bound to the rate of deflation away from the Friedman rule. There are also circumstances in which the best incentive-feasible monetary policy may entail a strictly positive rate of inflation. This will be the case, for example, if agents are sufficiently impatient or if there are rapidly diminishing returns to production.

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File URL: http://www.sfu.ca/econ-research/RePEc/sfu/sfudps/dp07-14.pdf
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Paper provided by Department of Economics, Simon Fraser University in its series Discussion Papers with number dp07-14.

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Length: 20 pages
Date of creation: 2007
Date of revision:
Handle: RePEc:sfu:sfudps:dp07-14
Contact details of provider: Postal: Department of Economics, Simon Fraser University, 8888 University Drive, Burnaby, BC, V5A 1S6, Canada
Phone: (778)782-3508
Fax: (778)782-5944
Web page: http://www.sfu.ca/economics.html
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Order Information: Postal: Working Paper Coordinator, Department of Economics, Simon Fraser University, 8888 University Drive, Burnaby, BC, V5A 1S6, Canada
Web: http://www.sfu.ca/economics/research/publications.html Email:


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  1. Ricardo Lagos & Guillaume Rocheteau, 2004. "Inflation, output, and welfare," Working Paper 0407, Federal Reserve Bank of Cleveland.
  2. Guillaume Rocheteau & Randall Wright, 2005. "Money in Search Equilibrium, in Competitive Equilibrium, and in Competitive Search Equilibrium," Econometrica, Econometric Society, vol. 73(1), pages 175-202, 01.
  3. Narayana R. Kocherlakota, 1996. "Money is memory," Staff Report 218, Federal Reserve Bank of Minneapolis.
  4. Christopher J. Waller, 2009. "Dynamic taxation, private information and money," Working Papers 2009-035, Federal Reserve Bank of St. Louis.
  5. Tai-wei Hu & John Kennan & Neil Wallace, 2009. "Coalition-Proof Trade and the Friedman Rule in the Lagos-Wright Model," Journal of Political Economy, University of Chicago Press, vol. 117(1), pages 116-137, 02.
  6. Shouyong Shi, 1997. "A Divisible Search Model of Fiat Money," Econometrica, Econometric Society, vol. 65(1), pages 75-102, January.
  7. Stephen Williamson, 2004. "Search, Limited Participation, and Monetary Policy," 2004 Meeting Papers 214, Society for Economic Dynamics.
  8. Deviatov Alexei & Wallace Neil, 2001. "Another Example in which Lump-sum Money Creation is Beneficial," The B.E. Journal of Macroeconomics, De Gruyter, vol. 1(1), pages 1-22, February.
  9. Kiyotaki, Nobuhiro & Wright, Randall, 1989. "On Money as a Medium of Exchange," Journal of Political Economy, University of Chicago Press, vol. 97(4), pages 927-54, August.
  10. Ricardo Lagos & Randall Wright, 2004. "A unified framework for monetary theory and policy analysis," Staff Report 346, Federal Reserve Bank of Minneapolis.
  11. Narayana Kocherlakota, 2002. "The Two-Money Theorem," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 43(2), pages 333-346, May.
  12. Levine, David K., 1991. "Asset trading mechanisms and expansionary policy," Journal of Economic Theory, Elsevier, vol. 54(1), pages 148-164, June.
  13. 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.
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