The Optimum Quantity of Money with Gold Reserves

Monetary policymakers target positive inflation. This divergence from the long accepted Friedman optimum of deflation is troubling: Why does theory seem so at odds with what policymakers view as optimal policy? Without ad hoc assumptions e.g., about price stickiness, the fundamental Friedman view that money’s marginal social cost of zero ought to equal the marginal social benefit (the nominal interest rate), remains unassailed and the optimum still is deflation. Presenting an economy where the central bank must hold gold reserves, the optimum is shown to be instead one of zero inflation, consistent with the Fisher price stability prescription.