Visiting Frank P. Ramsey: The Public Finance Concept of Optimal Monetary Policy

67 Pages Posted: 11 May 2007 Last revised: 15 Feb 2008

See all articles by Pedro Garcia Duarte

Pedro Garcia Duarte

University of São Paulo (FEA-USP) - Department of Economics

Date Written: December 1, 2007

Abstract

Nowadays monetary economists derive optimal policies by solving a Ramsey problem. In this paper I explore the historical context in which this concept of optimality emerged. This approach developed from two ideas. First, economists characterized inflation as a tax on money holdings in the postwar period. This idea is strongly associated with members of the University of Chicago such as Milton Friedman and Martin Bailey, who brought to monetary economics arguments about economic efficiency. The next step was taken by Edmund Phelps who developed a second-best version of Friedman's argument. Welfare-maximizing monetary policies were then formulated by using concepts and tools from the public finance literature. I discuss how monetary economists not only borrowed tools from public finance but also claimed one of its giants as their own: the Cambridge mathematician Frank Ramsey. In my narrative I first discuss Ramsey's original contribution to optimal taxation; I then analyze the circumstances in which Ramsey was rediscovered in the public finance literature in the late 1960s and early 1970s; finally, I study how monetary economists borrowed tools and heroes from public finance in the 1970s. Here also I ponder the current use of Ramsey optimality in monetary economics.

Keywords: Ramsey problem, optimal monetary policy, Friedman rule, inflation as a tax, Ramsey allocation, Frank Ramsey, Milton Friedman, Edmund Phelps

JEL Classification: E52, B22, B23, E50, E60

Suggested Citation

Garcia Duarte, Pedro, Visiting Frank P. Ramsey: The Public Finance Concept of Optimal Monetary Policy (December 1, 2007). Available at SSRN: https://ssrn.com/abstract=985331 or http://dx.doi.org/10.2139/ssrn.985331

Pedro Garcia Duarte (Contact Author)

University of São Paulo (FEA-USP) - Department of Economics ( email )

Av. Prof. Luciano Gualberto, 908
Departamento de Economia
Sao Paulo, SP, 05508-010
Brazil

HOME PAGE: http://www.usp.br/feaecon/perfil.php?u=110

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