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Money in the Production Function

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  • Edward C. Prescott
  • Ryan Wessel

Abstract

Businesses hold large quantities of cash reserves, which have average returns well below their investments in tangible capital. Businesses do this because these monetary assets provide services. One implication is that money services is a factor of production in capital theoretic valuation equilibrium models. Our aggregate production function is consistent with both the classical demand for money function relationship and with extended periods of near zero short-term nominal interest rates. In our model economy, there is a 100 percent reserve requirement on all demand deposits. Demand deposits are legal tender. We find (i) money services in the production function necessitates revisions in the national accounts; (ii) monetary and fiscal policy cannot be completely separated; (iii) for a given policy, equilibrium is either unique or does not exist; and (iv) Friedman?s monetary satiation is not optimal. We make quantitative comparisons between interest rate targeting regimes and between inflation rate targeting regimes. The best inflation rate target was 2 percent. {{p}} This paper is related to but fundamentally different from Staff Report 530: \\"Fiat Value in the Theory of Value.?

Suggested Citation

  • Edward C. Prescott & Ryan Wessel, 2018. "Money in the Production Function," Staff Report 562, Federal Reserve Bank of Minneapolis.
    • Handle: RePEc:fip:fedmsr:562
    DOI: 10.21034/sr.562
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    References listed on IDEAS

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    Keywords

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    JEL classification:

    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • E0 - Macroeconomics and Monetary Economics - - General
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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