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Federal Reserve Bank of Minneapolis
Staff Report
Money in the Production Function
Edward C. Prescott
Ryan Wessel
Abstract

Businesses hold large quantities of cash reserves, which have average returns well below their investments in tangible capital. Businesses do this because these monetary assets provide services. One implication is that money services is a factor of production in capital theoretic valuation equilibrium models. Our aggregate production function is consistent with both the classical demand for money function relationship and with extended periods of near zero short-term nominal interest rates. In our model economy, there is a 100 percent reserve requirement on all demand deposits. Demand deposits are legal tender. We find (i) money services in the production function necessitates revisions in the national accounts; (ii) monetary and fiscal policy cannot be completely separated; (iii) for a given policy, equilibrium is either unique or does not exist; and (iv) Friedman’s monetary satiation is not optimal. We make quantitative comparisons between interest rate targeting regimes and between inflation rate targeting regimes. The best inflation rate target was 2 percent.

This paper is related to but fundamentally different from Staff Report 530: "Fiat Value in the Theory of Value.”


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Edward C. Prescott & Ryan Wessel, Money in the Production Function, Federal Reserve Bank of Minneapolis, Staff Report 562, 10 Apr 2018.
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Keywords: 100 percent reserve banking; Money in production function; Interest rate targeting; Inflation rate targeting; Friedman monetary satiation; zero lower bound
DOI: 10.21034/sr.562
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