On the Essentiality of Credit and Banking at the Friedman Rule

PurposeThe paper includes characterizing Ramsey policy in a cash-in-advance monetary model, under flexible and sticky prices, and with different fiscal instruments.Design/methodology/approachThe paper analytically and numerically characterizes the dynamic properties of Ramsey allocations. The author computes dynamics by solving second-order approximations to the Ramsey planner’s policy functions around a non-stochastic Ramsey steady state.FindingsThe Friedman rule is not mainly optimal in a cash-in-advance model with distorting taxes. The Ramsey-optimal policy with both taxes on income and consumption calls for a high inflation rate that is extremely volatile, despite the fact that changing prices is costly.Practical implicationsThe optimality of zero nominal interest rate under flexible prices in monetary models is not mainly the case and quite depends on the preferences. The optimality of a zero inflation rate under sticky prices also very much depends on the assumed set of fiscal instruments.Originality/valueThe non-optimality of the Friedman rule under flexible prices is quite new. Moreover, studying the optimal fiscal and monetary policy in a New Keynesian model with a rich set of fiscal instruments is also quite original.

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The Friedman rule: Old and new

Journal of Monetary Economics ◽

10.1016/j.jmoneco.2006.06.008 ◽

2007 ◽

Vol 54 (2) ◽

pp. 581-589 ◽

Cited By ~ 15

Author(s):

Firouz Gahvari

Keyword(s):

Friedman Rule

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Risk Premia and the Real Effects of Money

The American Economic Review ◽

10.1257/aer.20180203 ◽

2020 ◽

Vol 110 (7) ◽

pp. 1995-2040 ◽

Cited By ~ 1

Author(s):

Sebastian Di Tella

Keyword(s):

Interest Rates ◽

Risk Premium ◽

Risk Sharing ◽

Optimal Allocation ◽

Price Theory ◽

The Real ◽

Friedman Rule ◽

Real Effects ◽

Tax Subsidy

This paper proposes a flexible-price theory of the role of money in an economy with incomplete idiosyncratic risk sharing. When the risk premium goes up, money provides a safe store of value that prevents interest rates from falling, reducing investment. Investment is too high during booms when risk is low, and too low during slumps when risk is high. Monetary policy cannot correct this: money is superneutral and Ricardian equivalence holds. The optimal allocation requires the Friedman rule and a tax/subsidy on capital. The real effects of money survive even in the cashless limit. (JEL E32, E41, E43, E44, E52)

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On the Welfare Cost of Inflation and the Recent Behavior of Money Demand

The American Economic Review ◽

10.1257/aer.99.3.1040 ◽

2009 ◽

Vol 99 (3) ◽

pp. 1040-1052 ◽

Cited By ~ 86

Author(s):

Peter N Ireland

Keyword(s):

Interest Rate ◽

Money Demand ◽

Demand Curve ◽

Nominal Interest Rate ◽

Welfare Cost Of Inflation ◽

Friedman Rule ◽

Long Run ◽

Income Ratio ◽

Interest Rate Rule ◽

Relationship Of

Post-1980 US data trace out a stable long-run money demand relationship of Cagan's semi-log form between the M1-income ratio and the nominal interest rate, with an interest semielasticity below 2. Integrating under this money demand curve yields estimates of the welfare costs of modest departures from Friedman's zero nominal interest rate rule for the optimum quantity of money that are quite small. The results suggest that the Federal Reserve's current policy, which generates low but still positive rates of inflation, provides an adequate approximation in welfare terms to the alternative of moving all the way to the Friedman rule. (JEL E31, E41, E52)

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Liquidity constraints, international trade, and optimal monetary policy

The B E Journal of Macroeconomics ◽

10.1515/bejm-2015-0203 ◽

2017 ◽

Vol 20 (2) ◽

Author(s):

Wai-Ming Ho

Keyword(s):

Open Economy ◽

Small Open Economy ◽

Capital Requirements ◽

Capital Inflows ◽

Working Capital ◽

Tax Rate ◽

Friedman Rule ◽

Domestic Credit ◽

International Borrowing ◽

The Government

AbstractThe availability of liquidity matters for an economy’s production and trade as firms need working capital to finance their operations. This paper studies the interaction between trade and capital flows operating through the liquidity allocations in the financial markets using a small-open-economy, overlapping-generations model. Working capital requirements distort the intratemporal consumption allocations. International capital inflows help easing liquidity in the domestic credit market, facilitating trade and improving the intratemporal allocation, while distorting the intertemporal allocation of the economy. We show how the government can use the Friedman rule and differentiated consumption taxes to address the tradeoff between the intratemporal and intertemporal distortions and achieve the second best optimum. Imposing a higher tax rate on imports can reduce the international borrowing to imports ratio and enhance the efficiency in using capital inflows to facilitate trade flows.

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