Incentives and the Limits to Deflationary Policy

I study a version of the Lagos-Wright (2005) model for which the Friedman rule is always a desirable policy, but where implementation may be constrained by the need to respect incentive-feasibility. In the environment I consider, incentives are distorted owing to private information and limited commitment. I demonstrate that a monetary economy can overcome the former friction, but not necessarily the latter. When this is so, there is an incentive-induced lower bound to the rate of deflation away from the Friedman rule. There are also circumstances in which the best incentive-feasible monetary policy may entail a strictly positive rate of inflation. This will be the case, for example, if agents are sufficiently impatient or if there are rapidly diminishing returns to production.

Monetary Implications of the Hayashi-Prescott Hypothesis for Japan

Japan, Productivity Slowdown, Liquidity Trap

Essential Interest-Bearing Money

In this paper, I provide a rationale for why money should earn interest; or, what amounts to the same thing, why risk-free claims to non-interest-bearing money should trade at discount. I argue that interest-bearing money is essential when individual money balances are private information. The analysis also suggests one reason for why it is sufficient (as well as necessary) for interest to be paid only on large money balances; or equivalently, why bonds need only be issued in large denominations.Money; Bonds; Monetary Policy; Friedman Rule

Bank Incentives, Contract Design, and Bank Runs

We study a version of the Diamond-Dybvig Green-Lin model with a strategic banker.

On the Coexistence of Money and Bonds

This paper re-examines the so-called coexistence puzzle in terms of a modified version of the legal restrictions hypothesis initially put forth by Bryant and Wallace (1980). The modification is in terms of dropping a questionable assumption in the original hypothesis; i.e., that large denomination government bonds cannot be intermediated by private banks. This restriction is replaced by one that is arguably more palatable; i.e., that the intermediated monetary instruments created by private banks are not universally acceptable as payment for all exchanges (unlike government money). The friction that gives rise to this latter restriction is one that is commonly employed in monetary models where fiat money is essential for exchange.

Money, Intermediation, and Banking

The business of money creation is conceptually distinct from that of intermediation. Yet, these two activities are frequently---but not always---combined together in the form of a banking system. We develop a simple model to examine the question: When is banking essential? There is a role for money due to a lack of record-keeping and a role for intermediation due to the existence of private information: both money and intermediation are essential. When monitoring costs associated with intermediation are sufficiently low, the two activities can be separated from one another. However, when monitoring costs are sufficiently high, a banking system that combines these two activities is essential.Money, Record-keeping, Private Information, Delegated Monitoring

The simple analytics of money and credit in a quasi-linear environment

Lagos and Wright (2005) demonstrate how the essential properties of a money-search model are preserved in an environment that is rendered highly tractable with the use of quasi-linear preferences. In this paper, I show that this same innovation can be applied to closely related environments used elsewhere in the literature that study insurance and credit markets under limited commitment and private information. The analysis demonstrates clearly how insurance, credit, and money are interrelated in terms of their basic functions. The analysis also leads to a heretofore neglected result pertaining to the Friedman rule. In particular, I find that the same frictions that render money essential may at the same time operate to render the Friedman rule infeasible. Thus, even if the Friedman rule is a desirable policy, an incentive-induced lower bound on the rate of deflation may nevertheless entail a strictly postive rate of inflation.Money ; Credit

On the social cost of transparency in monetary economies

I study a class of models commonly used to motivate monetary exchange, extended to include a physical asset whose expected short-run return is subject to exogenous news events, but whose expected long-run return is independent of this information. I show that there are circumstances in which the nondisclosure of news by an asset manager is welfare-improving. When nondisclosure is infeasible, the framework admits a role for government debt. The theory is used to interpret the nondisclosure practices of reputable financial agencies and suggests caveats for legislation designed to promote financial market transparency.Transparency ; Monetary policy