INFLATION AND CAPITAL ACCUMULATION IN MODELS OF OPTIMIZING BEHAVIOR (MONETARY, GROWTH THEORY)

Models of optimizing behavior are used to show how various assumptions affect the nature of the relationship one finds between nominal money growth and the stock of capital. The approach to real money demand based directly on a utility yield is seen to produce misleading results. In an infinite-horizon model that explicitly treats the transactions-based assumptions often underlying the use of that simplification, an inflation causes capital shallowing, given some degree of complementarity between money and capital. The conclusion yielded by either type of model tends more toward capital deepening in an overlapping-generations framework without bequests. This is because of that case's questionable implication that rentiers hold money without regard to the rate of inflation. When agents value the utility of their offspring sufficiently to induce any small bequest of capital, the results are identical to the infinite-horizon case.;The real effects of inflation also depend on the forces which generate nominal money growth when it is not determined exogenously. A fiscal authority is introduced to the transactions-based model, and fully-monetized deficits and proportional bond/money financing are analyzed. Except for a reduction in a linear tax rate, inflationary technological and policy changes cause capital shallowing, but the magnitude of the effect differs across the changes considered. A decline in the tax rate causes inflation and capital deepening, but the tax itself tends to magnify the negative impacts of other inflationary changes by linking those changes to the deficit and nominal money growth. An increase in the proportion of the deficit that is bond-financed is shown to be inflationary in the long run, and to induce capital shallowing. The change may also be inflationary in the short run, but not if the transaction technology is such that money demand is interest-inelastic, which is widely believed to be the case. The results agree with a broadening body of research which suggests that monetization of deficits is preferable to the issuance of interest-bearing debt.