Money and capital

The effects of money (anticipated inflation) on capital formation is a classic issue in macroeconomics. Previous papers adopt reduced-form approaches, putting money in the utility function, or imposing cash in advance, but using otherwise frictionless models. We follow instead a literature that tries to be explicit about the frictions making money essential. This introduces new elements, including a two-sector structure with centralized and decentralized markets, stochastic trading opportunities, and bargaining. These elements matter quantitatively and numerical results differ from findings in the reduced-form literature. The analysis also reduces a gap between microfounded monetary economics and mainstream macro. ► Extend the model in Lagos and Wright (2005) to have capital. ► Stochastic trading opportunities are critical for matching observation on velocity. ► Holdup problems involving investment and money demand are important. ► Monetary policy can have a bigger impact on investment than previously thought. ► Reduce the gap between micro-founded models of money and mainstream macro.