Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/189428 
Year of Publication: 
2011
Series/Report no.: 
Queen's Economics Department Working Paper No. 1152
Publisher: 
Queen's University, Department of Economics, Kingston (Ontario)
Abstract: 
Optimal monetary policy is studied in an environment in which money plays an essential role in facilitating exchange and aggregate shocks affect individual agents asymmetrically. Exchange may be conducted using either bank deposits (inside money) or fiat currency (outside money). A central monetary authority both controls the stock of outside money and pursues an interest rate policy that affects the rate at which private banks create inside money. We find that the optimal monetary policy requires management of both interest rates and the quantity of outside money. By controlling interest rates the monetary authority can affect the price level in the short-run and adjust households' consumption, thus providing insurance against unfavorable aggregate shocks. The feasibility of the interest rate policy requires a minimum rate of trend inflation that may be positive and in principle quite large. The paper thus links two principal components of monetary policy: the optimal interest rate policy and the optimal long-run inflation rate.
Subjects: 
banking
inside money
elastic money
monetary policy
inflation
zero bound
JEL: 
E43
E51
E52
Document Type: 
Working Paper

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