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Money, output and the payment system: Optimal monetary policy in a model with hidden effort

We propose a new explanation for the observed difference in the cost of intraday and overnight liquidity. We argue that the low cost of intraday liquidity is an application of the Friedman rule in an environment where a deviation of the Friedman rule is optimal with respect to overnight liquidity. In our environment the cost of overnight liquidity affects output while the cost of intraday liquidity only redistributes resources between money holders and non-money holders. We show that it is optimal to set a high overnight rate to reduce the incentives to overuse money. In contrast, intraday liquidity should have a low cost to provide risk-sharing.

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File URL: http://economics.missouri.edu/working-papers/2007/wp0704_haslag.pdf
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Paper provided by Department of Economics, University of Missouri in its series Working Papers with number 0704.

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Length: 23 pgs.
Date of creation: 14 Mar 2007
Date of revision:
Handle: RePEc:umc:wpaper:0704
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Web page: http://economics.missouri.edu/

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  1. Camera, Gabriele, 2001. "Dirty money," Journal of Monetary Economics, Elsevier, vol. 47(2), pages 377-415, April.
  2. Champ, B. & Snith, B.D. & Williamson, D.S., 1991. "Currency Elasticity and Banking Panics: Theory and Evidence," RCER Working Papers 292, University of Rochester - Center for Economic Research (RCER).
  3. Antinolfi, Gaetano & Keister, Todd, 2006. "Discount Window Policy, Banking Crises, And Indeterminacy Of Equilibrium," Macroeconomic Dynamics, Cambridge University Press, vol. 10(01), pages 1-19, February.
  4. Bhattacharya, Joydeep & Haslag, Joseph & Martin, Antoine, 2004. "Heterogeneity, Redistribution, and the Friedman Rule," Staff General Research Papers 11371, Iowa State University, Department of Economics.
  5. Mikhail Golosov & Narayana Kocherlakota & Aleh Tsyvinski, 2003. "Optimal Indirect and Capital Taxation," Review of Economic Studies, Oxford University Press, vol. 70(3), pages 569-587.
  6. University of Notre Dame & Christopher Waller, 2008. "Dynamic Taxation, Private Information and Money," 2008 Meeting Papers 896, Society for Economic Dynamics.
  7. Bech, Morten L. & Garratt, Rod, 2001. "The Intraday Liquidity Management Game," University of California at Santa Barbara, Economics Working Paper Series qt0m6035wg, Department of Economics, UC Santa Barbara.
  8. Bhattacharya, Joydeep & Haslag, Joseph & Martin, Antoine, 2005. "Sub-Optimality of the Friedman Rule in Townsend's Turnpike and Stochastic Relocation Models of Money: Do Finite Lives and Initial Dates Matter?," Staff General Research Papers 12265, Iowa State University, Department of Economics.
  9. Joseph H. Haslag & Antoine Martin, 2005. "Optimality of the Friedman rule in an overlapping generations model with spatial separation," Staff Reports 225, Federal Reserve Bank of New York.
  10. Schreft, Stacey L. & Smith, Bruce D., 1997. "Money, Banking, and Capital Formation," Journal of Economic Theory, Elsevier, vol. 73(1), pages 157-182, March.
  11. Carlos E. da Costa & Iván Werning, 2008. "On the Optimality of the Friedman Rule with Heterogeneous Agents and Nonlinear Income Taxation," Journal of Political Economy, University of Chicago Press, vol. 116(1), pages 82-112, 02.
  12. Angelini, Paolo, 1998. "An analysis of competitive externalities in gross settlement systems," Journal of Banking & Finance, Elsevier, vol. 22(1), pages 1-18, January.
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