Liquidity Effects with Long Lived Production Projects

This paper explores the effects of monetary shocks on the allocation of factors of production. We analyze these effects when money plays a role in improving the timing of the transactions undertaken by entrepreneurs. Such improvement is facilitated by money’s important role in providing liquidity to entrepreneurs. Using a model in which production processes take time to mature and where credit contracts are not enforceable, we show the consequences of monetary shocks for the allocation of resources and the real business cycle. Our analysis reveals that such shocks disrupt the allocation of resources with important effects on total factor productivity. * For correspondence: Sonia Laszlo, Department of Economics, University of Toronto, 150 St. George Street, Toronto, Ontario, M5S 3G7, Canada. Tel: 416-978-5103. Fax: 416-978-6713. E-mail: [email protected]