Money and Capital Adjustment: Revisiting the Role of Money for Production

Abstract

This study presents a new monetarist model, in which monetary liquidity is essential for capital adjustment, to analyze the effects of money growth on the production side. Results from revisiting the classic issue of money and capital with this model highlight the role of the diminishing rate of technical substitution between money and capital in the adjustment. When the substitutability between money and capital is sufficiently high, the positive Tobin effect of inflation on the aggregate capital stock and output can dominate the negative price distorting effect of inflation. This case will likely occur when search frictions in the capital market are severe.