Incentives and the Limits to Deflationary Policy

David Andolfatto (dxa1048@miami.edu)

Discussion Papers from Department of Economics, Simon Fraser University

Abstract: I study a version of the Lagos-Wright (2005) model for which the Friedman rule is always a desirable policy, but where implementation may be constrained by the need to respect incentive-feasibility. In the environment I consider, incentives are distorted owing to private information and limited commitment. I demonstrate that a monetary economy can overcome the former friction, but not necessarily the latter. When this is so, there is an incentive-induced lower bound to the rate of deflation away from the Friedman rule. There are also circumstances in which the best incentive-feasible monetary policy may entail a strictly positive rate of inflation. This will be the case, for example, if agents are sufficiently impatient or if there are rapidly diminishing returns to production.

Pages: 20 pages
Date: 2007
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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Citations: View citations in EconPapers (11)

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