The Tobin effect and the Friedman rule

Joydeep Bhattacharya (), Joseph Haslag () and Antoine Martin ()

No 224, Staff Reports from Federal Reserve Bank of New York

Abstract: This paper addresses whether the Friedman rule can be optimal in an economy in which the Tobin effect is operative. We present an overlapping generations economy with capital in which limited communication and stochastic relocation create an endogenous transaction role for fiat money. We assume a production function with a knowledge externality (Romer-style) that nests economies with endogenous growth (AK form) and those with no long-run growth (the Diamond model). With logarithmic utility, the "anti-Tobin effect" is operative, and the Friedman rule is optimal (that is, stationary-welfare-maximizing) regardless of whether or not there is long-run growth. Under the more general CRRA (constant relative risk aversion) form of preferences, we show that an operative anti-Tobin effect is a sufficient condition for the Friedman rule to be optimal. Also, contrary to models with linear storage technologies, our model shows that zero inflation is not optimal.

Keywords: Inflation (Finance); Money supply; Monetary policy; Friedman, Milton (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dge, nep-fin, nep-mac and nep-mon
Date: 2005
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