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Capacity Choice, Monetary Trade, and the Cost of Inflation

Garth Baughman () and Stanislav Rabinovich ()

No 2020-019, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

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 (search for similar items in EconPapers)
JEL-codes: D43 E31 E40 (search for similar items in EconPapers)
Pages: 23 p.
Date: 2020-02-24
New Economics Papers: this item is included in nep-dge, nep-mac and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgfe:2020-19

DOI: 10.17016/FEDS.2020.019

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