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Optimal monetary policy
Optimal monetary policy maximizes the welfare of a representative agent, given frictions in the economic environment. Constructing a model with two broad sets of frictions ? costly price adjustment by imperfectly competitive firms and costly exchange of wealth for goods ? we find optimal monetary policy is governed by two familar principles. ; First, the average level of the nominal interest rate should be sufficiently low, as suggested by Milton Friedman, that there should be deflation on average. Yet, the Keynesian frictions imply that the optimal nominal interest rate is positive. ; ...