Contemporary thought on the topic of money and growth

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Contemporary thought on the topic of money and growth has its origins in work by Tobin (1965). Tobin considers the allocation of a fixed flow of savings between two assets, money and physical capital. An increase in the rate of inflation lowers the real return on money, leading agents to substitute out of cash and into capital. That is higher rates of inflation are connected with larger capital stock and higher level of output per capita. In this model the decision is between money and physical assets. The starting point of the model is a production function of the classical type expressed as; y t = f ( k t –1 ) (1) 8 Thus in line with the Solowian growth theory under the assumption of fixed savings rate out of real income, asset accumulation will be equal to savings rate, s, times household income: 1 1 1 t t t t t t t t t t M M K s y N P P - - π + ∆ = + τ - + π (2) Expressing equation 2 in per capita quantities yield; 1 1 1 t t t t t t t t K n k k k k P n - - = - = ∆ - + (3) 9 1 1 1 1 1 t t t t t t t t t t t t t m M n k s y k n P N n -   π = + τ - - -   + π + +   (4) 1 1 1 ( ) 1 1 (1 )(1 ) 1 t t t t t t t t t t t t t t t m n k s f k M k n n n - - - π θ - π = + τ - - - + π + + π + + (5) 10 1 1 1 ( ) (1 ) (1 )(1 ) 1 t t t t t t t t t t n k sf k s M k n n - - - θ - π = - - - + π + + (6) In the steady state, k * = m * = 0 * * * * * 1 1 0 (1 )(1 ) (1 )(1 ) t t m m m m m n n - θ + θ = - = - = + π + + π + (7)
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156 Musibau Adetunji Babatunde & Muhammed Isa Shuaibu Since the growth of nominal money and population are constant in the steady state inflation will also be constant thus equation 7 becomes; * * * * * ( ) (1 ) 1 (1 )(1 ) t n f k s m k n n θ - π = - + + + π + (8) * * * ( ) (1 ) (1 ) f k s m nk θ - π = - + + θ (9) * * * ( ) (1 ) (1 ) f k s k nk θ - π = - ψ + + θ (10) 11 * * * ( ) (1 ) 1 f k s nk = - ψ + + π (11) Tobin’s framework shows that a higher inflation rate via money supply permanently raises the level of output. However, the effect on output growth is temporary, occurring during the transition from an initial steady state capital stock to a new steady state capital stock. Inflation induces greater capital accumulation and higher growth, only until the return to capital falls. Thereafter higher investment will cease and only steady state growth will result. Quite simply, the Tobin effect suggests that inflation causes individuals to substitute out of money and into interest earning assets, which leads to greater capital intensity and promotes economic growth. In effect, inflation exhibits a positive relationship to economic growth. Tobin (1972) also argued that, because of the downward rigidity of prices (including wages), the adjustment in relative prices during economic growth could be better achieved by the upward price movement of some individual prices.
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