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Capital market imperfections in a monetary growth model


  • Bruce D. Smith

    (Federal Reserve Bank of Minneapolis and University of Texas at Austin, Austin, TX 78712, USA)

  • John H. Boyd

    (Federal Reserve Bank of Minneapolis and Finance Department, 735 Management and Economics, University of Minnesota, 271 19th Avenue South, Minneapolis, MN 55455, USA)


We consider a monetary growth model essentially identical to that of Diamond (1965) and Tirole (1985), except that we explicitly model credit markets, a credit market friction, and an allocative function for financial intermediaries. These changes yield substantially different results than those obtained in more standard models. In particular, if any monetary steady state equilibria exist, there are generally two of them; one of these has a low capital stock and output level, and it is necessarily a saddle. The other steady state has a high capital stock and output level; either it is necessarily a sink, or its stability properties depend on the rate of money creation. It follows that monetary equilibria can be indeterminate, and nonconvergence phenomena can be observed. Increases in the rate of money creation reduce the capital stock in the high-capital-stock steady state. If the high-capital-stock steady state is not a sink for all rates of money growth, then increases in the rate of money growth can induce a Hopf bifurcation. Hence dynamical equilibria can display damped oscillation as a steady state equilibrium is approached, and limit cycles can be observed as well. In addition, in the latter case, high enough rates of inflation induce the kinds of "crises" noted by Bruno and Easterly (1995): when inflation is too high there are no equilibrium paths approaching the high-activity steady state.

Suggested Citation

  • Bruce D. Smith & John H. Boyd, 1998. "Capital market imperfections in a monetary growth model," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 11(2), pages 241-273.
  • Handle: RePEc:spr:joecth:v:11:y:1998:i:2:p:241-273
    Note: Received: November 18, 1995; revised version: March 26, 1996

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    JEL classification:

    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy


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