DP2548 Should We be Afraid of Friedman's Rule?

Author(s): Harald Uhlig
Publication Date: September 2000
Keyword(s): Baby-Sitting Coop, Cash In Advance, Deflation, Deflationary Spiral, Friedman's Rule, Japan, Liquidity Trap, Optimal Monetary Policy, Zero Lower Bound On Nominal Interest Rates
JEL(s): E31, E41, E50, E51, E52
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=2548

Should one think of zero nominal interest rates as an undesirable liquidity trap or as the desirable Friedman rule? I use three different frameworks to discuss this issue. First, I restate Cole and Kocherlakota's (1998) analysis of Friedman's rule: short run increases in the money stock - whether through issuing spending coupons, open market operations or foreign exchange intervention - change nothing as long as the money stock shrinks in the long run. Second, two simple ?Keynesian? models of the inflationary process with a zero lower bound on nominal interest rates imply either that deflationary spirals should be common or that a policy close to the Friedman rule and thus some deflation is optimal. Finally, a formal ?baby-sitting coop? model implies multiple equilibria, but does not support the injection of liquidity to restore the good equilibrium, in contrast to Krugman (1998).