State Dependent Monetary Policy

32 Pages Posted: 27 Oct 2013

See all articles by Francesco Lippi

Francesco Lippi

Università degli Studi di Sassari; Einaudi Institute for Economics and Finance (EIEF)

Stefania Ragni

Università degli Studi di Sassari

Nicholas Trachter

Federal Reserve Banks - Federal Reserve Bank of Richmond

Date Written: October 23, 2013

Abstract

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.

Keywords: Incomplete markets, Heterogenous agents, Liquidity, Precautionary savings

JEL Classification: E50

Suggested Citation

Lippi, Francesco and Ragni, Stefania and Trachter, Nicholas, State Dependent Monetary Policy (October 23, 2013). FRB Richmond Working Paper No. 13-17. Available at SSRN: https://ssrn.com/abstract=2345294 or http://dx.doi.org/10.2139/ssrn.2345294

Francesco Lippi

Università degli Studi di Sassari ( email )

Piazza Universita
Sassari, 07100
Italy

Einaudi Institute for Economics and Finance (EIEF) ( email )

Via Due Macelli, 73
Rome, 00187
Italy

Stefania Ragni

Università degli Studi di Sassari ( email )

Piazza Universita
Sassari, 07100
Italy

Nicholas Trachter (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Richmond ( email )

P.O. Box 27622
Richmond, VA 23261
United States

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