The Role of Search Frictions in the Long-Run Relationship Between Inflation and Capital

Pedro Gomis-Porqueras, Stella Huangfu and Hongfei Sun

No 2019-19, Working Papers from University of Sydney, School of Economics

Abstract: This paper explores the long-run relationships among inflation, capital accumulation and unemployment. We find that in the U.S. data, inflation and the capital to output ratio are positively correlated, while in a cross-section of 49 countries, a non-monotonic relationship exists between inflation and the investment to output ratio. To reconcile these empirical findings, we propose a general equilibrium framework with frictions in both labor and goods markets. This framework allows us to highlight the following two channels through which monetary policy affects capital accumulation: extensive and intensive margins. Due to the opposing effects on these two margins, our model predicts that an inverted U-shaped relationship exists between inflation and capital in the long run. The nonlinearity identified by our model strongly contrasts previous findings suggesting either a positive or a negative correlation between money and capital. Our work provides novel insight into a classical issue.

Keywords: Monetary Policy; Inflation; Unemployment; Capital; Search Frictions (search for similar items in EconPapers)
Date: 2019-08
New Economics Papers: this item is included in nep-fdg and nep-mac
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Persistent link: https://EconPapers.repec.org/RePEc:syd:wpaper:2019-19

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