Money and Growth in a Production Economy with Multiple Assets

We consider a Diamond-type model of endogenous growth in which there are three assets: fiat money, government bonds, and equity. Because of productivity shocks, the equity return is uncertain, and risk-averse investors require a positive equity premium. Typically, there exist two steady states, but only one of them turns out to be stable. Tight monetary policy is harmful for growth in the stable steady state. These results hold under four different monetary policy strategies applied by the monetary authority. A monetary contraction increases the bond return and reduces the equity premium and thereby capital investment and growth.