Positive Nominal Interest Rate Research Articles

Monetary Policy in a Schumpeterian Growth Model with Two R&D Sectors

We explore the growth and welfare effects of monetary policy in a two-sector Schumpeterian economy with cash-in-advance (CIA) constrained R&D investment in both sectors. We show that a nominal interest rate increase generates two effects on equilibrium labor allocation: a manufacturing-R&D-reallocation effect and a cross-R&D-sector effect. The former reduces economic growth by shifting labor from R&D to production, whereas the latter can enhance it by shifting labor from the less productive R&D sector to the more productive one. From the welfare perspective, we show that unless the high productivity R&D sector is severely more CIA-constrained than the low productivity one, aggregate R&D overinvestment is sufficient but not necessary for the Friedman rule of monetary policy to be suboptimal. Our benchmark parameterization suggests that a positive nominal interest rate is optimal despite that it exacerbates the aggregate R&D underinvestment problem.

Monetary Policy, Financial Frictions, and Heterogeneous R&D Firms in an Endogenous Growth Model*

AbstractMotivated by empirical facts, I construct an endogenous growth model in which heterogeneous research and development (R&D) firms are financially constrained and use cash to finance R&D investments. I also examine the optimal monetary policy. The effects of financial constraint crucially depend on whether R&D firms are homogeneous or heterogeneous regarding R&D productivity. If R&D firms are homogeneous, then the zero nominal interest rate (i.e., the Friedman rule) is always optimal under severe financial constraint. Heterogeneity in R&D productivity leads to the opposite result. With heterogeneity, severe financial constraint makes the strictly positive nominal interest rate welfare‐improving under a plausible condition.

Optimal Monetary Policy in an Overlapping Generations Model with Search Theoretic Monetary Exchange

AbstractIt is well-known that in the monetary OLG models, a deviation from the Friedman rule can improve welfare because it generates intergenerational wealth transfers; however, the rule becomes optimal if the age-specific lump-sum tax policy is available. We revisit the issue using a microfounded model of money with centralized and decentralized markets. The individuals live for two periods. The young individuals work, receive wage income and hold money and capital in the centralized market. They also trade goods in the decentralized markets either as a buyer or a seller. Only money is accepted as a means of payment in the decentralized markets. The old individuals consume all their wealth in the centralized market. The quantity in the decentralized market negatively depends on the seller’s wealth, because the marginal utility of consumption in the centralized market is diminishing, but the buyer takes it as exogenous. Therefore, the equilibrium wealth exceeds the socially optimal level under the Friedman rule. A positive nominal interest rate makes money holdings costly, reduces wealth and improves welfare, even if the government optimally uses the age-specific tax.

TEMPTATION AND SELF-CONTROL IN A MONETARY ECONOMY

We construct a microfounded model of money with Gul–Pesendorfer preferences. In each period, agents are tempted to spend all their money by the end of the period, and they suffer from the forgone utility that could have been obtained by adopting the tempting choice. We find that the Friedman rule may not be optimal. A positive nominal interest rate improves welfare because it reduces the real money balances and renders the temptation less attractive. The welfare gained by deviating from the rule is equivalent to 0.67% of consumption.

Scarcity of Safe Assets, Inflation, and the Policy Trap

We construct a model in which all consolidated government debt is used in transactions, with money being more widely acceptable. When asset market constraints bind, the model can deliver low real interest rates and positive rates of inflation at the zero lower bound. Optimal monetary policy in the face of a financial crisis shock implies a positive nominal interest rate. The model reveals some novel perils of Taylor rules.

Scarcity of Safe Assets, Inflation, and the Policy Trap

We construct a model in which all consolidated government debt is used in transactions, with money being more widely acceptable. When asset market constraints bind, the model can deliver low real interest rates and positive rates of inflation at the zero lower bound. Optimal monetary policy in the face of a financial crisis shock implies a positive nominal interest rate. The model reveals some novel perils of Taylor rules.

Optimal Monetary Policy in OLG Models with Long‐Lived Agents: A Note

AbstractThis note reexamines Crettez, Michel, and Wigniolle (), who studied a two‐period overlapping generations model with cash‐in‐advance constraints and showed that a combination of saving tax and monetary policy involving positive nominal interest rates could achieve the first‐best allocation. The note shows that their result does not hold if agents live for three periods. The implementation of the first best requires the Friedman rule. If agents are long‐lived, saving tax cannot offset a distortion caused by the positive nominal interest rate.

WEALTH INEQUALITY AND OPTIMAL MONETARY POLICY

We study the money-in-the-utility-function model in which agents are heterogeneous in their initial wealth. We show that the Friedman rule is not optimal even if the government uses nonlinear income taxation for redistribution. A positive nominal interest rate raises social welfare because it relaxes the incentive compatibility constraint for highly endowed agents. Although the setup is close to that of da Costa and Werning [Journal of Political Economy (2008) 116, 82–112], who investigate skill heterogeneity, the role of the nominal interest rate in this paper here differs from the one in their model.

Essential interest-bearing money

I examine optimal monetary policy in a Lagos and Wright [R. Lagos, R. Wright, A unified framework for monetary theory and policy analysis, J. Polit. Economy 113 (2005) 463–484] model where trade is centralized and all exchange is voluntary. I identify a class of incentive-feasible policies that improve welfare beyond what is achievable with zero intervention. Any policy in this class necessarily entails a non-negative inflation rate and a strictly positive nominal interest rate. Despite the absence of a lump-sum tax instrument, there exists an incentive-feasible policy that implements the first-best allocation.

Essential Interest-Bearing Money

I examine optimal monetary policy in a Lagos and Wright [A unified framework for monetary theory and policy analysis, J. Polit. Econ. 113 (2005) 463—484] model where trade is centralized and all exchange is voluntary. I identify a class of incentive feasible policies that improve welfare beyond what is achievable with zero intervention. Any policy in this class necessarily entails a non-negative inflation rate and a strictly positive nominal interest rate. Despite the absence of a lump-sum tax instrument, there exists an incentive-feasible policy that implements the first-best allocation.

Welfare-Improving Credit Controls

Credit controls are generally believed to result in an inefficient allocation of resources. This paper presents a counterexample. It displays a general equilibrium, multi-good model with spatial separation for which steady state equilibria exist in which both cash (i.e. fiat currency) and trade credit are used in exchange. Transaction costs, restrictions on the timing of trade, and a positive nominal interest rate cause the laissez-faire equilibrium to be non-optimal. A quantitative restriction on the use of trade credit can yield a Pareto superior allocation.

Welfare-improving credit controls

Credit controls are generally believed to result in an inefficient allocation of resources. This paper presents a counterexample. It displays a general equilibrium, multi-good model with spatial separation for which steady state equilibria exist in which both cash (i.e., fiat currency) and trade credit are used in exchange. Transaction costs, restrictions on the timing of trade, and a positive nominal interest rate cause the laissez-faire equilibrium to be nonoptimal. A quantitative restriction on the use of trade credit can yield a Pareto-superior allocation.