Money and Asset Prices in a Production Economy

Abraham Lioui () and Patrice Poncet

Finance, 2010, vol. 31, issue 2, 007-049

Abstract: We generalize the monetary economy with cash and credit goods pioneered by Lucas and Stokey (1983, 1987) to the case of a neoclassical production economy. Assuming a fairly general continuous time stochastic process for real capital returns, we show that money non-neutrality is generic, even though the money growth rate is i.i.d. and the representative agent?s utility is log separable. We also show that the capital to wealth ratio plays a key role in the transmission mechanism by which monetary policy affects the dynamics of all real variables, in particular those of the pricing kernel and of asset excess returns. We finally provide some empirical evidence that supports the hypothesized influence of the capital to wealth ratio on the US equity market premium.

Date: 2010
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