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Money, Liquidity, and the Structure of Production

33 Pages Posted: 22 Feb 2015 Last revised: 15 Mar 2017

Joshua R. Hendrickson

University of Mississippi

Alexander William Salter

Texas Tech University - Rawls College of Business

Date Written: October 6, 2016

Abstract

We use a model in which media of exchange are essential to examine the role of liquidity and monetary policy on production and investment decisions in which time is an important element. Specifically, we consider the effects of monetary policy on the length of production time and entry and exit decisions for firms. We show that higher rates of inflation cause households to substitute away from money balances and increase the allocation of bonds in their portfolio thereby causing a decline in the real interest rate. The decline in the real interest rate causes the period of production to increase and the productivity thresholds for entry and exit to decline. This implies that when the real interest rate declines, prospective firms are more likely to enter the market and existing firms are more likely to stay in the market. Finally, we present reduced form empirical evidence consistent with the predictions of the model.

Keywords: forced saving, monetary policy, optimal stopping times, entry and exit

JEL Classification: E14, E22, E52

Suggested Citation

Hendrickson, Joshua R. and Salter, Alexander William, Money, Liquidity, and the Structure of Production (October 6, 2016). Journal of Economic Dynamics and Control, Vol. 73, 2016. Available at SSRN: https://ssrn.com/abstract=2567014 or http://dx.doi.org/10.2139/ssrn.2567014

Joshua R. Hendrickson (Contact Author)

University of Mississippi ( email )

Oxford, MS 38677
United States

Alexander William Salter

Texas Tech University - Rawls College of Business ( email )

Lubbock, TX 79409
United States

HOME PAGE: http://awsalter.com

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