Money and the Terms of Trade

Abstract

This paper examines the connection between money and the terms of trade in the context of a simple monetary equilibrium model with flexible prices. Money is held for transactions purposes. Because carrying out financial transactions is costly, households visit their financial intermediaries only occasionally. An important feature of the model is that different households visit the financial intermediaries at different times. This is sufficient to ensure that even though the model features perfect foresight and competitive markets, monetary policies affect output under both fixed and flexible exchange rates. Moreover, in the latter regime expansionary monetary policies tend to worsen the terms of trade while this is not the case under fixed exchange rates.