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.
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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.
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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
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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