Inflation, Trade Frictions, and Productive Activity in a Multiple-Matching Model of Money

Derek Laing, Victor E. Li, and Ping Wang
Working Paper 2000-28
November 2000

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This paper investigates the relationship between money growth, inflation, and productive activity in a general equilibrium model of search. The use of a multiple-matching technique, where trade frictions are captured by limited consumption variety, allows us to study price determination in a search-theoretic environment with divisible money and goods. In our basic framework, productive activity and matching in the goods market are endogenized by a time allocation decision of work and shopping effort. We find that in such an environment, a positive feedback between shopping and work effort decisions creates a channel by which inflation can positively influence productive activity. This feature also creates the possibility of multiple steady state equilibria when household preferences for variety is sufficiently great. We also consider an alternative means of endogenizing the matching technology through endogenous firm entry. Consistent with the findings of our basic framework, the importance of search frictions continues to be essential for the non-uniqueness of equilibria and an additional channel which links money growth to real activity.

JEL classification: D83, E40, E31

Key words: multiple matching, endogenous search effort, money, inflation and productivity activity

The authors thank Daron Acemoglu, Ben Bernanke, Dean Corbae, Yi-ting Li, Peter Morgan, Shoyoung Shi, Neil Wallace, Randy Wright, Mike Woodford, and Ruelin Zhou, as well as participants at the Summer Meeting of the Econometric Society and workshops at the University of Pittsburgh, Princeton University, and Texas A&M University. The views expressed here are the authors’ and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors’ responsibility.

Please address questions regarding content to Victor Li, Research Department, Federal Reserve Bank of Atlanta, 104 Marietta Street, N.W., Atlanta, GA 30303, 404-498-8938,; Derek Laing, Penn State University; or Ping Wang, Vanderbilt University.