Bhattacharya, Joydeep; Haslag, Joseph; Martin, Antoine; Singh, Rajesh

Economic Inquiry Vol. 46 no. 2 (April 2008): 113-130. (Originally published as WP #04030, November 2004)

In this paper, we explore the connection between optimal monetary policy and heterogeneity among agents. We study a standard monetary economy with two types of agents in which the stationary distribution of money holdings is non-degenerate. Sans type-specific fiscal policy, we show that the zero-nominal-interest rate policy (the Friedman rule) does not maximize type-specific welfare; it may not maximize aggregate social welfare either. Indeed, one or, more surprisingly, both types may benefit if the central bank deviates from the Friedman rule. Our results suggest a positive explanation for why central banks around the world do not implement the Friedman rule.

JEL Classification: E31, E51, E58

Keywords: Friedman rule, monetary policy, money-in-the-utility-function

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