Abstract
This paper sets up a monetary endogenous growth model with Benhabib–Farmer production externalities for an open economy, and then uses it to investigate the possibility of indeterminacy. Moreover, the paper examines how the monetary authorities will set its optimal anchor of the money growth rate from the viewpoint of welfare maximization. Several main findings emerge from the analysis. First, when investment does not involve adjustment costs, the monetary equilibrium is locally determinate regardless of the strength of the labor externality and the extent of world capital market imperfections. Second, in the presence of investment adjustment costs, the monetary equilibrium may exhibit indeterminacy when the aggregate increasing returns-to-scale in production is sufficiently strong. Third, in the presence of world capital market imperfections, the Friedman rule of a zero nominal interest rate fails to be optimal. Fourth, in the face of perfect world capital markets, the optimal nominal money growth rate is maintained at the rate that is conformable to the Friedman rule, regardless of whether investment involves adjustment costs or not.
This is a preview of subscription content, access via your institution.
References
Abel A.B., Blanchard O.J.: An intertemporal model of saving and investment. Econometrica 51, 673–692 (1983)
Arseneau D.M.: The inflation tax in an open economy with imperfect competition. Rev Econ Dyn 10, 126–147 (2007)
Benhabib J., Farmer R.E.A.: Indeterminacy and increasing returns. J Econ Theory 63, 19–41 (1994)
Benhabib J., Farmer R.E.A.: Indeterminacy and sector-specific externalities. J Monet Econ 37, 421–444 (1996)
Buiter W.H.: Saddlepoint problems in continuous time rational expectations models: A general method and some macroeconomic examples. Econometrica 52, 665–680 (1984)
Burmeister E.: On some conceptual issues in rational expectations modeling. J Money Credit Bank 12, 800–816 (1980)
Cooley T.F., Quadrini V.: Common currencies vs. monetary independence. Rev Econ Stud 70, 785–806 (2003)
Correia I., Teles P.: The optimal inflation tax. Rev Econ Dyn 2, 325–346 (1999)
Cunha A.B.: The optimality of the Friedman rule when some distorting taxes are exogenous. Econ Theory 35, 267–291 (2008)
Edwards S.: LDC foreign borrowing and default risk: An empirical investigation, 1976–1980. Am Econ Rev 74, 726–734 (1984)
Eicher T.S., Turnovsky S.J., Walz U.: Optimal policy for financial market liberalizations: Decentralization and capital flow reversals. German Econ Rev 1, 19–42 (2000)
Farmer R.E.A., Guo J.T.: Real business cycles and the animal spirits hypothesis. J Econ Theory 63, 42–73 (1994)
Feichtinger G., Kort P.M., Hartl R.F., Wirl F.: The dynamics of a simple relative adjustment cost framework. German Econ Rev 2, 255–268 (2001)
Friedman M.: The Optimum Quantity of Money and Other Essays. Macmillan, London (1969)
Guidotti P.E., Vegh C.A.: The optimal inflation tax when money reduces transactions costs: A reconsideration. J Monet Econ 31, 189–205 (1993)
Guo J.T., Lansing K.J.: Indeterminacy and stabilization policy. J Econ Theory 82, 481–490 (1998)
Hayashi F.: Tobin’s marginal and average q: A neoclassical interpretation. Econometrica 50, 213–224 (1982)
Ho W.M., Zeng J., Zhang J.: Inflation taxation and welfare with externalities and leisure. J Money Credit Bank 39, 105–131 (2007)
Itaya J.I., Mino K.: Inflation, transaction costs and indeterminacy in monetary economies with endogenous growth. Economica 70, 451–470 (2003)
Ireland P.N.: Implementing the Friedman rule. Rev Econ Dyn 6, 120–134 (2003)
Lahiri A.: Growth and equilibrium indeterminacy: The role of capital mobility. Econ Theory 17, 197–208 (2001)
Meng Q., Velasco A.: Indeterminacy in a small open economy with endogenous labor supply. Econ Theory 22, 661–669 (2003)
Meng Q., Velasco A.: Market imperfections and the instability of open economies. J Int Econ 64, 503–519 (2004)
Romer P.M.: Increasing returns and long-run growth. J Polit Econ 94, 1002–1037 (1986)
Shaw M.F., Lai C.C., Chang W.Y.: Anticipated policy and endogenous growth in a small open monetary economy. J Int Money Finance 24, 719–743 (2005)
Suen M.H., Yip C.K.: Superneutrality, indeterminacy and endogenous growth. J Macroeconomics 27, 579–595 (2005)
Turnovsky S.J.: Fiscal policy, growth, and macroeconomic performance in a small open economy. J Int Econ 40, 41–66 (1996)
Turnovsky S.J.: Equilibrium growth in a small economy facing an imperfect world capital market. Rev Dev Econ 1, 1–22 (1997)
Turnovsky S.J.: Methods of Macroeconomic Dynamics, 2nd edn. MIT Press, Cambridge (2000)
Weder M.: Indeterminacy in the small open economy Ramsey growth model. J Econ Theory 98, 339–356 (2001)
Wen Y.: Capacity utilization under increasing returns to scale. J Econ Theory 81, 7–36 (1998)
Zhang J.: Inflation and growth: pecuniary transactions costs and qualitative equivalence. J Money Credit Bank 32, 1–12 (2000)
Author information
Authors and Affiliations
Corresponding author
Additional information
We are deeply grateful to Jang-Ting Guo, Ping Wang, an anonymous referee, and a co-editor, Stephen D. Williamson for their insightful comments that substantially improved the paper. We would also like to thank Fu-Sheng Hung, Chih-Hsing Liao, and Hsueh-fang Tsai for their helpful suggestions in relation to a previous version of this article. Financial support from the National Science Council of Taiwan, under grant NSC 96-2752-H-001-002-PAE, is gratefully acknowledged.
Rights and permissions
About this article
Cite this article
Lai, Cc., Chin, Ct. (In)determinacy, increasing returns, and the optimality of the Friedman rule in an endogenously growing open economy. Econ Theory 44, 69–100 (2010). https://doi.org/10.1007/s00199-009-0457-x
Received:
Accepted:
Published:
Issue Date:
DOI: https://doi.org/10.1007/s00199-009-0457-x
Keywords
- Endogenous growth
- Small open economy
- Imperfect capital markets
- Investment adjustment costs
- The Friedman rule
JEL Classification
- F41
- F43
- O42