On the Monetary Endogenous Growth Model with Idiosyncratic Investment Risk

In this paper, we construct a monetary endogenous growth model with idiosyncratic risk in capital formation and study the relationship between monetary policy and economic growth. The model features two types of consumption goods, namely cash goods and credit goods, with money being required to purchase cash goods. We first show that when the inflation rate is low, capital accumulation and economic growth are encouraged. As the inflation rate increases, the economic growth rate begins to decline. Therefore, the nominal interest rate and the economic growth rate have an inverted-U relationship. We next show that the Friedman rule of setting the nominal interest rate to zero is not the optimal monetary policy. Instead, the social welfare-maximizing nominal interest rate is always positive. Inflation stimulates risky investment, which raises the economic growth rate and increases utility. Finally, the introduction of government bonds into our model does not affect resources allocation.