Government Policy in Monetary Economies

37 Pages Posted: 13 Apr 2012

See all articles by Fernando M. Martin

Fernando M. Martin

Federal Reserve Banks - Federal Reserve Bank of St. Louis

Multiple version iconThere are 2 versions of this paper

Date Written: January 24, 2012


I study how the general and specific details of a micro founded monetary framework affect the determination of policy when the government has limited commitment. The conduct of policy depends on the interaction between the incentive to smooth distortions intertemporally and a time-consistency problem. In equilibrium, fiscal and monetary policies are distortionary, but long-run policy is not aicted by time-consistency problems. Policy variables in specific applications of the general framework react similarly to variations in fundamentals. Nevertheless, resolving certain environment frictions affect long-run policy significantly. The response of government policy to aggregate shocks is qualitatively similar across the studied model variants. However, there are significant quantitative differences in the response of government policy to productivity shocks, mainly due to the idiosyncratic behavior of the money demand. Environments with no trading frictions display the best fit to post-war U.S. data.

Keywords: government policy, limited commitment, Markov-perfect equilibrium, financial intermediation, trading frictions, micro founded models of money

JEL Classification: E13, E52, E62, E63

Suggested Citation

Martin, Fernando M., Government Policy in Monetary Economies (January 24, 2012). Available at SSRN: or

Fernando M. Martin (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of St. Louis ( email )

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