Usefulness of the Constrained Planning Problem in a Model of Money

Journal of Economic Dynamics and Control

Singh

2010

Self Cite

The tug-o-war for supremacy between in ‡ation targeting and monetary targeting is a classic yet timely topic in monetary economics. In this paper, we revisit this question within the context of a pure-exchange overlapping generations model of money where spatial separation and random relocation create an endogenous demand for money. We distinguish between shocks to real output and shocks to the real interest rate. Both shocks are assumed to follow AR (1) processes. Irrespective of the nature of shocks, the optimal in ‡ation target is always positive. Under monetary targeting, shocks to endowment require negative money growth rates, while under shocks to real interest rates it may be either positive or negative depending on the elasticity of consumption substitution. Also, monetary targeting welfare-dominates in ‡ation targeting but the gap between the two vanishes as the shock process approaches a random walk. In sharp contrast, for shocks to the real interest rate, we prove that monetary targeting and in ‡ation targeting are welfare-equivalent only in the limit when the shocks become i.i.d.! The upshot is that persistence of the underlying fundamental uncertainty matters: depending on the nature of the shock, policy responses can either be more or less aggressive as persistence increases.JEL Classi…cation: E31, E42, E63

Section: Introductionmentioning

confidence: 99%

“…As a result, the volatility of optimal in ‡ation declines with the persistence of shocks. 5 In equilibrium, relocated old agents use money to purchase out of the endowment deposited by the current young. From a planner's perspective, ex-ante, what is consumed by the relocated agents can not be stored.…”

Section: Introductionmentioning

confidence: 99%

Optimal monetary rules under persistent shocks

Journal of Economic Dynamics and Control

Singh

2010

Self Cite

“…3 Since banks can pool individual risks, it can be checked that the latter strategy always dominates the former and we will analyze the economy on this basis. 4 Monetary policy in ‡uences the bank's ability to provide risk sharing, an issue which lies at the heart of our 3 Limited communication disallows banks from communicating in any way with banks on the other island; in particular, the bank may not "wire money" or issues checks etc. 4 Relocation status is public information; concerns regarding bank runs do not appear here.…”

Section: Random Relocationmentioning

confidence: 99%

“…As shown by Bhattacharya and Singh (2007), solving a constrained planning problem turns out to be analytically much simpler in such environments. 19 Therefore, we will …rst compute the allocations under a constrained planning problem and then work out the implied state-contingent rules.…”

Section: State-contingent Rulesmentioning

confidence: 99%

“…Under the planner's allocation, the indirect utility of a representative household is given by: 19 Bhattacharya and Singh (2007) describe the construct of a constrained planning problem as follows: "Consider a decentralized economy with a speci…ed set of markets, rules of trade, an equilibrium concept, and a policy regime (a restricted set of policies). Such a speci…cation of markets and rules of the game generates a set of equilibrium allocations that are attainable by a policymaker in the decentralized economy from within that policy regime.…”

Section: State-contingent Rulesmentioning

confidence: 99%

See 1 more Smart Citation

Optimal Choice of Monetary Instruments in an Economy With Real and Liquidity Shocks

Singh

2007

SSRN Journal

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Faced with real and nominal shocks, what should a benevolent central bank do, …x the money growth rate or target the in ‡ation rate? In this paper, we make a …rst attempt at studying the optimal choice of monetary policy instruments in a micro-founded model of money. Speci…cally, we produce an overlapping generations economy in which limited communication and stochastic relocation creates an endogenous transactions role for …at money. We …nd that when the shocks are real, welfare is higher under money growth targeting; when the shocks are nominal and not large, welfare is higher under in ‡ation rate targeting. While under in ‡ation rate targeting, it is always optimal to pursue an expansionary policy, it is never optimal to do so under money growth targeting.JEL Classi…cation: E31, E42, E63

Why does overnight liquidity cost more than intraday liquidity?

Journal of Economic Dynamics and Control

Haslag

Martin

2009

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In this paper, we argue that the observed difference in the cost of intraday and overnight liquidity is part of an optimal payments system design. In our environment, overnight liquidity affects output while intraday liquidity affects only the distribution of resources between money holders and non-money holders. The low cost of intraday liquidity is explained by the Friedman rule. The optimal cost differential achieves the twin objective of reducing the incentive to overuse money at night and encouraging payment-risk sharing during the day. KeywordsFriedman rule, monetary policy, overnight liquidity, intraday liquidity, random-relocation models AbstractIn this paper, we argue that the observed di¤erence in the cost of intraday and overnight liquidity is part of an optimal payments system design. In our environment, the interest charged on overnight liquidity a¤ects output while the cost of intraday liquidity only a¤ects the distribution of resources between money holders and non-money holders. The low cost of intraday liquidity follows from the Friedman rule and it is optimal to deviate from the the Friedman rule with respect to overnight liquidity. The cost di¤erential simultaneously reduces the incentive to overuse money and encourages risk sharing.