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Working Paper

Money and Capital

We revisit classic questions concerning the effects of money on investment in a new framework: a two-sector model where some trade occurs in centralized and some in decentralized markets, as in recent monetary theory, but extended to include capital. This allows us to incorporate novel elements from the microfoundations literature on trading with frictions, including stochastic exchange opportunities, alternative pricing mechanisms, etc. We calibrate models with bargaining and with price taking in the decentralized market. With bargaining, inflation has little impact on investment, but a sizable impact on welfare: going from 10% inflation to the Friedman rule e.g. barely affects capital, but is worth 3% of consumption. With price taking, this policy increases capital between 3% and 5%, and is worth 1.5% of consumption across steady states or 1% with transition. Fiscal distortions are also big. So is the impact of holdup problems from bargaining, even if the decentralized market accounts for only 5% of output. Many of these numbers are quite different from previous studies. Our two-sector specification is a key to the results.

Working Papers of the Federal Reserve Bank of Cleveland are preliminary materials circulated to stimulate discussion and critical comment on research in progress. They may not have been subject to the formal editorial review accorded official Federal Reserve Bank of Cleveland publications. The views expressed in this paper are those of the authors and do not represent the views of the Federal Reserve Bank of Cleveland or the Federal Reserve System.


Suggested Citation

Aruoba, S. Borağan, Christopher Waller, and Randall Wright. 2007. “Money and Capital.” Federal Reserve Bank of Cleveland, Working Paper No. 07-14. https://doi.org/10.26509/frbc-wp-200714