Borrowing constraints and monetary policy: The inflation tax-net worth channel

Abstract

Kiyotaki and Moore’s Financial Accelerator framework (J Polit Econ 105(2):211-248, 1997, Am Econ Rev 92(2):46-50, 2002, Am Econ Rev 92(2):62-66, 2002) is the natural vehicle to explore the net worth channel of the monetary transmission mechanism. In the original model, however, all the variables, credit included, are in real terms. In order to assess the impact of monetary policy the model must be reformulated to fit a monetary economy. In the present paper we model a monetary economy with financing constraints adopting the Money In the Utility function approach. The occurrence of multiple equilibria is a likely outcome of the dynamics generated by the model. A change in the growth rate of money supply can affect real output through the impact of inflation on net worth. In this context, the monetary transmission mechanism consists of a combination of the inflation tax effect and the net worth channel.