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

By Joseph H. Haslag and Antoine Martin
June 2003 
RWP 03-03
Research Division 
Federal Reserve Bank of Kansas City 

Abstract

      Recent papers suggest that when intermediation is analyzed seriously, the Friedman rule does not maximize social welfare in overlapping generations model in which money is valued because of spatial separation and limited communication. These papers emphasize a trade-off between productive efficiency and risk sharing. We show financial intermediation or a trade-off between productive efficiency and risk sharing are neither necessary nor sufficient for that result. We give conditions under which the Friedman rule maximizes social welfare and show any feasible allocation such that money grows faster than the Friedman rule is Pareto dominated by a feasible allocation with the Friedman rule. The key to the results is the ability to make intergenerational transfers.

Keywords: Friedman rule, overlapping generations, spatial separation

JEL Codes: E52, E58, H21

Joseph H. Haslag is an associate professor at the Economics Department at the University of Missouri-Columbia and Antoine Martin is an economist at the Federal Reserve Bank of Kansas City. The authors thank Scott Freeman, Jordan Rappaport, Gordon Sellon, and Pu Shen for useful comments. All remaining errors are their own. The views expressed here are those of the authors and not necessarily those of the Federal Reserve Bank of Kansas City or the Federal Reserve System.

Haslag e-mail:  haslagj@missouri.edu
Martin e-mail:  antoine.martin@kc.frb.org

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