Firm's demand for money: Feenstra equivalence, monetary super-neutrality and technical inefficiency

This study investigates the implications of firm's demand for real balances from the production and monetary economics perspective. Money is a component of production as a factor increasing efficiency in exchange in input markets. Firms may improve efficiency in production by holding real money to decrease their transactions cost in input market. Feenstra (1986) equivalence states that transactions cost as a constraint in a firm's budget is functionally equivalent to money in the production function. Monetary expansion may change transactions cost, hence can affect the efficiency in both goods and input markets. If a monetary model is set up in accordance with Feenstra equivalence it can be used to examine the impact of the change in money supply over net consumption and net input. Monetary expansion is no longer super-neutral over net consumption and net input because it has the ability to alter efficiency in exchange. The study concludes with an empirical test of the theory by applying the stochastic production frontier approach over 12 European Union countries. The test verifies the significance of real money in determining the technical inefficiency in production.