Question

Suppose that consumers are concerned about theft, and so they are willing to use banks for some of their transactions even if the nominal interest rate is zero. Further, suppose that, the more currency consumers hold, the more people are encouraged to steal, as theft is now more profitable.
How would the Friedman rule for monetary policy be altered under these circumstances?

Answer 1

According to the Friedman Rule for Monetary Policy, when the nominal interest rate is zero then people don't loose by holding money in hand. Initially Friedman did not consider any case of theft which would have discouraged him to propound such theory.

When the nominal interest rate is zero and the real interest rate is equal to the disinflation, people will have to pay to the banks to keep the money . The marginal benefit which people would derive from keeping the money in bank will be more than the marginal cost associated with those who keep money in the hand and on the verge of theft.

Friedman's rule will be altered in the way so as to secure a considerable benefit for people keeping money in bank even though they had to pay the interest as security measure. The loss in the theft would have been far more than the loss in the interest payable. So if we increase the nominal rate to certain extent that people feel that its costly to keep the money at home then they will certainly choose banks as profitable measure. So the Nominal Interest rate would be no longer zero. But it would be still be lower than the inflation rate so that banks are ready to keep the deposit at profit .