Academic journal article Journal of Money, Credit & Banking

Imperfect Information, Money, and Economic Growth

Academic journal article Journal of Money, Credit & Banking

Imperfect Information, Money, and Economic Growth

Article excerpt

It is typically argued that informational imperfections in credit markets or borrowing constraints tend to amplify the impact of policy intervention. Models of informational imperfections in credit markets like Stiglitz and Weiss (1981) and Greenwald and Stiglitz (1988a), and models with exogenous finance constraints (for example, Greenwaid and Stiglitz 1988b) suggest that, by changing the financial positions of credit-constrained individuals, economic shocks will have important and significant effects on economic behavior. Consequently, the economy will be affected more dramatically by changes in policies than if there is full information. However, by not explicitly considering an economic environment in which the finance constraints arise endogenously, these models overlook the important issue of how such economic shocks affect the financing decisions of economic agents. In order to examine the economic significance of finance constraints, this paper presents an endogenous growth model in which there is an explicit treatment of the informational asymmetries giving rise to finance constraints in the credit market. The model is used to study the effects of money growth on economic growth and to investigate the role of informational imperfections in the determination of the equilibrium growth path. As demonstrated below, this model suggests that informational imperfections make the economy less responsive to monetary policy changes rather than amplifying their effects.

The impact of money growth in the basic neoclassical growth model has been addressed in many papers. Tobin (1965) considers a portfolio allocation problem between capital and money. Given a declining marginal productivity of capital, individuals adjust their Portfolio until the marginal return on capital equals that on money. Higher money growth reduces the rate of return on money. This induces Portfolio substitution, resulting in an increase in the capital stock and a decrease in the quantity of real balances in the steady state.(1) Levhari and Patinkin (1968) assign two different roles to money - as either a consumer or producer good, in which case, money services enter either the utility function or the production function. Their results suggest that money growth can either raise or lower the steady-state capital stock. Some studies of money and growth using the cash-in-advance approach (see, for example, Stockman 1981) demonstrate that when a cash-in-advance constraint is imposed on both consumption and investment, higher money growth leads to a lower capital stock in the steady state.(2)

A number of recent papers have extended this analysis to endogenous growth models. Howitt (1990) modifies Uzawa's (1965) model of endogenous growth to incorporate a transaction technology in which real money balances play the role of reducing transaction costs. Therefore, the transaction-impeding aspect of inflation is emphasized. He finds that the model can magnify the nonsuperneutralities of money. The negative effects of long-term monetary expansion on economic growth and the real rate of interest are also an implication of his model. Gomme (1993) studies the welfare costs of money growth in an endogenous growth model that features a cash-in-advance constraint on consumption. In his model, endogenous growth arises through human capital accumulation as suggested by Lucas (1988). With the existence of the cash-in-advance constraint, money growth reduces labor supply by lowering the effective return on working. Consequently, the real rate of growth of the economy falls as money growth rises.

In contrast, this paper introduces money to the model as one of the portfolio choices of individuals. As in Romer (1986), externalities in production imply that production technologies display increasing social returns to scale, which allows for endogenous growth. In the model's equilibrium, an increase in money growth induces agents to shift away from money and toward physical investment, which in turn raises the rate of economic growth. …

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