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Incentives and the Limits to Deflationary Policy

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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.

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  • David Andolfatto, 2007. "Incentives and the Limits to Deflationary Policy," Discussion Papers dp07-14, Department of Economics, Simon Fraser University.
    • Handle: RePEc:sfu:sfudps:dp07-14
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    Cited by:

    1. Andolfatto, David, 2010. "Essential interest-bearing money," Journal of Economic Theory, Elsevier, vol. 145(4), pages 1495-1507, July.
    2. Antinolfi, Gaetano & Azariadis, Costas & Bullard, James, 2016. "The Optimal Inflation Target In An Economy With Limited Enforcement," Macroeconomic Dynamics, Cambridge University Press, vol. 20(2), pages 582-600, March.
    3. Guillaume Rocheteau, 2008. "Money and competing assets under private information," Working Papers (Old Series) 0802, Federal Reserve Bank of Cleveland.
    4. Sanches, Daniel & Williamson, Stephen, 2010. "Money and credit with limited commitment and theft," Journal of Economic Theory, Elsevier, vol. 145(4), pages 1525-1549, July.
    5. Berentsen, Aleksander & Monnet, Cyril, 2008. "Monetary policy in a channel system," Journal of Monetary Economics, Elsevier, vol. 55(6), pages 1067-1080, September.
    6. Andolfatto, David, 2010. "Essential interest-bearing money," Journal of Economic Theory, Elsevier, vol. 145(4), pages 1495-1507, July.
    7. Stephen Williamson & Daniel Sanches, 2008. "Money and Credit with Limited Commitment," 2008 Meeting Papers 502, Society for Economic Dynamics.
    8. Alessandro Marchesiani & Aleksander Berentsen, 2010. "Standing Facilities Versus Open Market Operations: Equivalence Results," 2010 Meeting Papers 929, Society for Economic Dynamics.
    9. Li, Yiting & Wang, Chien-Chiang, 2019. "Cryptocurrency, Imperfect Information, and Fraud," MPRA Paper 94309, University Library of Munich, Germany.
    10. Guillaume Rocheteau, 2009. "A monetary approach to asset liquidity," Working Papers (Old Series) 0901, Federal Reserve Bank of Cleveland.

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    JEL classification:

    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • E0 - Macroeconomics and Monetary Economics - - General

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