Money and Interest in a Simple Production Economy

Abstract

In this paper, I study the effects of government open market operations on households' production and interest rates. I show that if the degree of relative risk aversion is less (greater) than one, then a known, temporary increase in future money growth increases (decreases) a bond holder's production and decreases (increases) a money holder's production. However, the distributional effects tend to cancel out when aggregated. I also show that mean money growth increases bond market participation; the variance of money growth rates increases (decreases) bond market participation if the degree of relative risk aversion is less (greater) than one. Finally, if the degree of relative risk aversion is less than one and the initial inflation is low, then an increase in money growth may increase real interest, a reversal of the Mundell-Tobin effect. If the initial inflation is high or the degree of relative risk aversion is greater than one, the Mundell-Tobin effects tend to hold.