Optimal fiscal and monetary policy when money is essential
University of Maryland
Lagos-Wright search-based monetary model with capital accumulation (AWW extension), featuring decentralized market (DM) with bilateral trading and centralized market (CM), where money is essential due to explicit spatial and informational frict
CM firms: perfectly competitive with CRS technology; DM sellers: bilateral production using capital and effort
Optimal policy features strictly positive net nominal interest rate; Friedman Rule is not optimal; deviation from zero inflation due to need to tax cash-intensive activities
Main theoretical result of the paper: Propositions 3 and 4 establish that Friedman Rule (zero nominal interest rate/deflation) is typically not optimal