Implementing the Friedman Rule by a Government Loan Program: An Overlapping Generations Model

Abstract

The welfare gains from adopting a zero nominal interest policy depend on the implementation details. Here I argue that implementing the Friedman rule by a government loan program may be better than implementing it by collecting taxes, even when lump sum taxes are possible. The government loan program will crowd out lending and borrowing and other money substitutes. Since money can be costlessly created the resources spent on creating money substitutes are a "social waste". Moving from an economy with strictly positive nominal interest rate to an economy with zero nominal interest rate will increase consumption by the amount of resources spent on lending and borrowing. But in general welfare will increase by more than that because consumption smoothing is better under zero nominal interest rate.