WP Global Economy 2015.09.08
We investigate a monetary model `a la Lagos and Wright (2005), in which there are two kinds of decentralized markets, and each agent stochastically chooses which one to participate in by expending effort. In one market, the pricing mechanism is competitive, whereas in the other market, the terms of trade are determined by Nash bargaining. It is shown that the optimal monetary policy may deviate from the Friedman rule. As the nominal interest rate deviates from zero, buyers expend more effort because a higher interest rate increases the gain for buyers from entering the competitive market, while the marginal increase in social welfare by entering the competitive market is also positive.