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Indeterminacy in a Matching Model of Money with Productive Government Expenditure

Chu, Angus C. and Liao, Chih-Hsing and Liu, Xiangbo and Zhang, Mengbo (2015): Indeterminacy in a Matching Model of Money with Productive Government Expenditure.

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Abstract

This study explores the effects of inflation on economic growth in a monetary search-and-matching model with productive government expenditure. Our results can be summarized as follows. When labor intensity in the production function is below a threshold value, the economy features a unique balanced growth equilibrium in which inflation reduces economic growth. When labor intensity in the production function is above a threshold value, the economy may feature multiple balanced growth paths. Multiple equilibria (i.e., global indeterminacy) arise when the matching probability in the decentralized market is sufficiently large. In this case, the high-growth equilibrium features a negative effect of inflation on economic growth whereas the low-growth equilibrium features a U-shaped effect of inflation on growth. Furthermore, under a sufficiently large matching probability in the decentralized market, both equilibria are locally determinate, and hence, either equilibrium may emerge in the economy.

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