MONEY AND GROWTH IN A PRODUCTION ECONOMY WITH MULTIPLE ASSETS

Abstract

We consider a Diamond-type model of endogenous growth in which there are three assets: fiat money, government bonds, and equity. Because of productivity shocks, the equity return is uncertain, and risk-averse investors require a positive equity premium. Typically, there exist two steady states, but only one of them turns out to be stable. Tight monetary policy is harmful for growth in the stable steady state. These results hold under four different monetary policy strategies applied by the monetary authority. A monetary contraction increases the bond return and reduces the equity premium and thereby capital investment and growth.The research on this paper originated while Gerd Weinrich was visiting the Institute of Advanced Studies, Vienna. The authors thank an anonymous associate editor, Klaus Ritzberger, participants at the EEA2000 Congress, and seminar participants at the Catholic University of Milan for helpful comments. All remaining errors and shortcomings are our own responsibility.