Optimality of the Friedman Rule in an Overlapping Generations Model with Spatial Separation


  • We thank anonymous referees, Scott Freeman, Jordan Rappaport, Gordon Sellon, and Pu Shen, as well as seminar participants at the University of Arkansas, the University of Kansas, and the University of Kentucky for useful comments. We also thank Joydeep Bhattacharya and Steve Russell for many conversations on the topic. All remaining errors are our own. Part of this paper was written while Antoine Martin was at the Federal Reserve Bank of Kansas City. The views expressed here are those of the authors and not necessarily those of the Federal Reserve Bank of New York, the Federal Reserve Bank of Kansas City, or the Federal Reserve System.


Recent models with spatial separation and limited communication suggest that the Friedman rule may not be optimal. This is important in light of the disparity between theory and practice concerning optimal monetary policy. We take a close look at these models and show that intergenerational transfers are key to the suboptimality of the Friedman rule. The Friedman rule is a necessary condition for achieving the efficient allocation in equilibrium. We also show that the Friedman rule is chosen whenever agents can implement mutually beneficial arrangements.