Real effects of money growth and optimal rate of inflation in a cash-in-advance economy with labor-market frictions

Wang, Ping and Xie, Danyang (2012): Real effects of money growth and optimal rate of inflation in a cash-in-advance economy with labor-market frictions.

Abstract

This paper studies the consequences of labor-market frictions for the real effects of steady inflation when cash is required for households' consumption purchases and firms' wage payments. Money growth may generate a positive real effect by encouraging vacancy creation and raising job matches. This may result in a positive optimal rate of inflation, particularly in an economy with moderate money injections to firms and with nonnegligible labor-market frictions in which wage bargains are not efficient. This main finding holds for a wide range of money injection schemes, with alternative cash constraints, and in a second-best world with pre-existing distortionary taxes.

• Item Type: MPRA Paper
• Language: English
• Keywords: Cash Constraints; Nonsuperneutrality of Money; the Friedman rule; Labor-Market Frictions
• Subjects: O - Economic Development, Innovation, Technological Change, and Growth > O4 - Economic Growth and Aggregate Productivity > O42 - Monetary Growth Models; D - Microeconomics > D9 - Intertemporal Choice > D90 - General; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E41 - Demand for Money

References

Ahmed, S. and J. H. Rogers (2000), "Inflation and the Great Ratios: Long Term Evidence from the U.S.," Journal of Monetary Economics, 45: 3-35.

Andolfatto, D. (1996), "Business Cycles and Labor-Market Search," American Economic Review, 86: 112-132.

Atkinson, A. B. and J. E. Stiglitz (1972), "The Structure of Indirect Taxation and Economic Efficiency," Journal of Public Economics, 1: 97-119.

Bullard, J. and J. Keating (1995), "The Long-run Relationship Between Inflation and Output in Postwar Economies," Journal of Monetary Economics, 36: 477-96.

Chang, W. Y. and H. F. Tsai (2003), "Money, Social Status, and Capital Accumulation in a Cash-in-Advance Model: A Comment," Journal of Money, Credit and Banking, 35: 657-661.

Chari, V. V., L. J. Christiano and P. J. Kehoe (1996), "Optimality of the Friedman Rule in Economies with Distorting Taxes," Journal of Monetary Economics, 37: 203-223.

Chari, V. V. and P. J. Kehoe (1999), "Optimal Fiscal and Monetary Policy," in J. B. Taylor and M. Woodford (eds.), Handbook of Macroeconomics, Volume 1, Part 3, 1671-1745.

Carlstrom, C. and T. Fuerst (1995), "Interest Rate Rules Vs. Money Growth Rules: A Welfare Comparison in a Cash-in-Advance Economy," Journal of Monetary Economics, 36: 247-267.

Christiano, L. and M. Eichenbaum (1995), "Liquidity Effects, Monetary Policy, and the Business Cycle," Journal of Money, Credit and Banking, 27: 1113-1136.

Cole, H. L. and L. E. Ohanian (1998), "The Demand for Money and the Neutrality of Money," Federal Reserve Bank of Minneapolis Staff Report No. 246.

Cooley, T. F. and G. D. Hansen (1989), "The Inflation Tax in a Real Business Cycle Model," American Economic Review, 79: 733-748.

Diamond, P. (1982), "Wage Determination and Efficiency in Search Equilibrium," Review of Economic Studies, 49: 217-227.

Diamond, P. A. and J. A. Mirrless (1971), "Optimal Taxation and Public Production II: Tax rules," American Economic Review, 61: 261-268.

Dotsey, M. and P. D. G. Sarte (2000), "Inflation uncertainty and growth in a cash-in-advance economy," Journal of Monetary Economics, 45: 631-655.

Fischer, S. (1983), "Inflation and Growth," NBER Working Paper No. 1235.

Fuerst, T. S. (1992), "Liquidity, Loanable Funds, and Real Activity," Journal of Monetary Economics, 29: 3-24.

Gomme, P. (1993), "Money and growth revisited," Journal of Monetary Economics, 32: 51-77.

Hosios, A. (1990), "On the Efficiency of Matching and Related Models of Search and Unemployment," Review of Economic Studies, 57: 279-298.

Jones, L. and R. Manuelli (1995), "Growth and the Effects of Inflation," Journal of Economic Dynamics and Control, 19: 1405-1428.

Khan, M. S. and A. S. Senhadji (2000),"Threshold Effects in the Relationship Between Inflation and Growth," IMF Working Paper No. 00/110.

Laing, D. , T. Palivos, and P. Wang (1995), Learning, matching, and growth, Review of Economic Studies, 62: 115-129.

Li V. E. and C. Y. Chang (2004), "The Cyclical Behavior of Household and Business Investment in a Cash-in-Advance Economy," Journal of Economic Dynamics and Control, 28: 691-706.

Liu, J. T., M. W. Tsou, and P. Wang (2008), "Differential Cash Constraints, Financial Leverage and the Demand for Money: Evidence from a Complete Panel of Taiwanese Firms," Journal of Macroeconomics, 30: 523-542.

Lucas, R. E. Jr. (1972), "Expectations and the Neutrality of Money," Journal of Economic Theory, 4: 103-124.

Lucas, R. E. Jr. (1980), "Equilibrium in a Pure Currency Economy," Economic Inquiry, 18: 203-220.

Lucas, R. E. Jr., (1990), "Liquidity and Interest Rates," Journal of Economic Theory, 50: 237-264.

Merz, M. (1995), "Search in the Labor Market and the Real Business Cycle," Journal of Monetary Economics, 36: 269--300.

Mortensen, D. T. (1982), "Property Rights and Efficiency in Mating, Racing and Related Games," American Economic Review, 72: 968-969.

Mundell, R. A. (1963), "Inflation and Real Interest," Journal of Political Economy, 71: 280-283.

Peters, M. (1991), "Ex Ante Price Offers in Matching Games: Non-Steady State," Econometrica, 59: 1425-1454.

Pissarides, C. A. (1984), "Efficient Job Rejection," Economic Journal, 94, S97-S108.

Rogers, J., and P. Wang (1993), "Sources of Fluctuations in Relative Prices: Evidence from High Inflation Countries," Review of Economics and Statistics, 70: 589-605.

Stockman, Alan C. (1981), "Anticipated Inflation and the Capital Stock in a Cash-in-Advance Economy," Journal of Monetary Economics, 8: 387-393.

Tobin, James (1956), "The Interest-Elasticity of the Transactions Demand for Cash," Review of Economics and Statistics, 38: 241-247.

Wang, P. and C. Yip (1992), "Alternative Approaches to Money and Growth," Journal of Money, Credit and Banking, 24: 553-562.