Money and Capital

58 Pages Posted: 17 Oct 2007 Last revised: 23 Oct 2007

See all articles by S. Borağan Aruoba

S. Borağan Aruoba

University of Maryland - Department of Economics

Christopher J. Waller

Federal Reserve Banks - Federal Reserve Bank of St. Louis; University of Notre Dame - Department of Economics

Randall Wright

University of Wisconsin - Madison - Department of Finance, Investment and Banking; Federal Reserve Banks - Federal Reserve Bank of Minneapolis

Date Written: October 2007

Abstract

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 percent inflation to the Friedman rule e.g. barely affects capital, but is worth 3 percent of consumption. With price taking, this policy increases capital between 3 percent and 5 percent, and is worth 1.5 percent of consumption across steady states or 1 percent 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 percent of output. Many of these numbers are quite different from previous studies. Our two-sector specification is a key to the results.

Keywords: bargaining, price taking, centralized markets, decentralized markets, capital, inflation, investment, welfare

JEL Classification: C78, E44

Suggested Citation

Aruoba, S. Boragan and Waller, Christopher J. and Wright, Randall D., Money and Capital (October 2007). FRB of Cleveland Working Paper No. 07-14, Available at SSRN: https://ssrn.com/abstract=1021809 or http://dx.doi.org/10.2139/ssrn.1021809

S. Boragan Aruoba

University of Maryland - Department of Economics ( email )

College Park, MD 20742
United States
301-405-3508 (Phone)
301-405-3542 (Fax)

Christopher J. Waller

Federal Reserve Banks - Federal Reserve Bank of St. Louis

411 Locust St
Saint Louis, MO 63011
United States

University of Notre Dame - Department of Economics ( email )

434 Flanner Hall
Notre Dame, IN 46556
United States
574-631-4963 (Phone)
574-631-9238 (Fax)

HOME PAGE: http://www.nd.edu/~cwaller/

Randall D. Wright (Contact Author)

University of Wisconsin - Madison - Department of Finance, Investment and Banking ( email )

975 University Avenue
Madison, WI 53706
United States
608-263-3860 (Phone)

Federal Reserve Banks - Federal Reserve Bank of Minneapolis

90 Hennepin Avenue
Minneapolis, MN 55480
United States

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