Capacity Choice, Monetary Trade, and the Cost of Inflation

23 Pages Posted: 18 May 2020

See all articles by Garth Baughman

Garth Baughman

Board of Governors of the Federal Reserve System

Stanislav Rabinovich

University of North Carolina (UNC) at Chapel Hill

Date Written: February 24, 2020

Abstract

Firms often make production decisions before meeting a buyer. We incorporate this often-overlooked fact into an otherwise standard monetary search model and show that it has important implications for the set of equilibria, efficiency, and the cost of inflation. Our model features a strategic complementarity between the buyers' ex ante choice of money balances and sellers' ex ante choice of productive capacity. When resale value of unsold inventories is high, sellers carry excess capacity and the equilibrium is unique. But, when resale value is low, there is a continuum of equilibria, all of which are inefficient and welfare-ranked. Effects of inflation are highly nonlinear. When inflation is high, the buyer's money holdings bind, and inflation therefore reduces trade through a standard real-balance channel. When inflation is low, the seller's capacity constraint binds, real balances have no effect at the margin, and inflation has no effect on output or welfare.

Keywords: Search; Money; New monetarism; Inflation

JEL Classification: D43; E31; E40

Suggested Citation

Baughman, Garth and Rabinovich, Stanislav, Capacity Choice, Monetary Trade, and the Cost of Inflation (February 24, 2020). FEDS Working Paper No. 2020-019 https://doi.org/10.17016/FEDS.2020.019 , Available at SSRN: https://ssrn.com/abstract=3601247

Garth Baughman (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Stanislav Rabinovich

University of North Carolina (UNC) at Chapel Hill ( email )

102 Ridge Road
Chapel Hill, NC NC 27514
United States

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