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Monetary Policies with Increasing Returns

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  • G. Chichilnisky
  • Geoffrey M. Heal

Abstract

The paper studies a two-sector monetary economy with two factors of production, labor and capital. The industrial sector has increasing returns to scale, the consumption sector non-increasing returns. All firms maximize profits and markets clear. For each rate of return on capital the model reaches a general equilibrium with an associated demand for money. A monetary policy is a quantity of money supplied. We prove that restrictive monetary policies decrease the level of operation and profits of the increasing returns to scale sector and eventually force it to operate with negative profits, so that it must close down. The other sector of the economy, however, expands with more restrictive monetary policies, but national income as a whole decreases. Monetary policies affect the rate of interest of the economy and determine whether or not competitive market equilibria exist with a positive output in the increasing returns sector. With very restrictive monetary policies, the only market equilibria with continued output from the increasing returns sector are those where this sector is being subsidized. There are, therefore, two choices open to this economy: either adequate liquidity is provided to allow the increasing returns sector to behave competitively and produce positive output, or else this sector must be regulated and subsidized to prevent it from closing down.

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File URL: http://cowles.econ.yale.edu/P/cd/d06b/d0662.pdf
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Bibliographic Info

Paper provided by Cowles Foundation for Research in Economics, Yale University in its series Cowles Foundation Discussion Papers with number 662.

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Length: 24 pages
Date of creation: Feb 1983
Date of revision:
Handle: RePEc:cwl:cwldpp:662

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References

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  1. Brown, Donald J & Heal, Geoffrey, 1979. "Equity, Efficiency, and Increasing Returns," Review of Economic Studies, Wiley Blackwell, vol. 46(4), pages 571-85, October.
  2. Weitzman, Martin L, 1982. "Increasing Returns and the Foundations of Unemployment Theory," Economic Journal, Royal Economic Society, vol. 92(368), pages 787-804, December.
  3. Hahn, Frank, 1990. "On Inflation," Oxford Review of Economic Policy, Oxford University Press, vol. 6(4), pages 15-25, Winter.
  4. Chichilnisky, Graciela, 1981. "Terms of trade and domestic distribution : Export-led growth with abundant labour," Journal of Development Economics, Elsevier, vol. 8(2), pages 163-192, April.
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Cited by:
  1. Chichilnisky, Graciela, 1986. "Trade and development in the 1980s," MPRA Paper 8035, University Library of Munich, Germany.

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