Endogenous Specialization and Factor Substitution in a Monetary Growth Model
We study the effects of monetary policy on the choice of production technology and specialization. The level of output specialization is represented by the elasticity of substitution between capital and labor within a CES production function. A higher degree of specialization increases trading costs but also improves productivity. Money is introduced via a cash-in-advance constraint on consumption and specialization. Agents having access to a menu of production functions differing in the elasticity of substitution choose the optimal degree of specialization along with real money balances. Depending on the stage of development as measured by the initial degree of specialization both a Tobin and a reverse-Tobin effect can occur.
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