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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 two-sector monetary search-and-matching model with productive government expenditure. Our results can be summarized as follows. When labor intensity of production in the centralized market is below a threshold value, the economy features a unique balanced growth path (BGP). On this BGP, inflation reduces economic growth so long as capital intensity of production in the decentralized market is positive. When labor intensity in the centralized market is above the threshold however, 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 may feature a negative effect, a positive effect or 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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