Implementing the Friedman Rule

In cash-in-advance models, necessary and sufficient conditions for the existence of an equilibrium with zero nominal interest rates and Pareto optimal allocations place restrictions only on the very long-run, or asymptotic, behavior of the money supply. When these asymptotic conditions are satisfied, they leave the central bank with a great deal of flexibility to manage the money supply over any finite horizon. But what happens when these asymptotic conditions fail to hold? This paper shows that the central bank can still implement the Friedman rule if its actions are appropriately constrained in the short run. JEL: E52. ∗Please address correspondence to: Peter N. Ireland, Boston College, Department of Economics, 140 Commonwealth Avenue, Chestnut Hill, MA 02467-3806. Tel: (617) 552-3687. Fax: (617) 552-2308. Email: [email protected]. Some of this work was completed while I was visiting the Research Department at the Federal Reserve Bank of Cleveland; I would like to thank the Bank and its staff for their hospitality and support. The opinions expressed herein are my own and not those of the Federal Reserve Bank of Cleveland or the Federal Reserve System.