Money In A Model With Overlapping Production Activities

This paper advances a model which can account for these five prominent facts of monetary economics. (i) Money is held in non trivial amounts even though it is a dominated asset. (ii) High rates of inflation lead to low rates of growth. (iii) Monetary injections momentarily depress the rate of interest. (iv) Hyper-inflations can be ended with a minimal loss of output. (v) Liquidity crises lead to recessions. The model advanced develops the second variation in Woodford (1990). The model is designed to capture three features of reality, which form the basis for modeling money as a dominated asset: Income and expenditures by households and firms are not synchronized. Money is used to transfer income from the time it is received to the time it is spent because real assets are costly to liquidate, and capital markets are imperfect. And money improves the allocation of resources by providing flexibility to the timing of consumption and investment. In this model, monetary shocks affect total factor productivity. Hence, the model offers a link between the real business cycle model and a monetary approach to the business cycle.