Abstract
The issue of optimal monetary policy within a particular general equilibrium model of the monetary transmission mechanism is addressed. The model analyzed is a member of the recent class of “liquidity models” of the monetary business cycle. The nature of the trading frictions that define these models introduces a role for activist monetary policy. In particular, to the extent that the central bank can adjust liquidity more rapidly than the private sector, there is a welfare‐improving role for monetary policy. In contrast to traditional policy prescriptions for “aggregate demand management,” this is a prescription for “liquidity management.”
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