Discussion Paper Details

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Title: State dependent monetary policy

Author(s): Francesco Lippi, Stefania Ragni and Nicholas Trachter

Publication Date: January 2014

Keyword(s): distributional effects, heterogenous agents, incomplete markets, liquidity and precautionary savings

Programme Area(s): International Macroeconomics

Abstract: We study the optimal anticipated monetary policy in a flexible-price economy featuring heterogenous agents and incomplete markets, which give rise to a business cycle. In this setting money policy has distributional effects that depend on the state of the cycle. We parsimoniously characterize the dynamics of the economy and study the optimal regulation of the money supply as a function of the state. The optimal policy prescribes monetary expansions in recessions, when insurance is most needed by cash- poor unproductive agents. To minimize the inflationary effect of these expansions the policy prescribes monetary contractions in good times. Although the optimal money growth rate varies greatly through the business cycle, this policy ?echoes? Friedman?s principle in the sense that the expected real return of money approaches the rate of time preference.

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Bibliographic Reference

Lippi, F, Ragni, S and Trachter, N. 2014. 'State dependent monetary policy'. London, Centre for Economic Policy Research.