Social status, inflation and endogenous growth in a cash-in-advance economy : a reconsideration using the credit channel

Abstract

Conventional models of social status purport a positive inflation‐growth relationship, and attribute this empirical contradiction to the presence of a consumer's desire for social status. These models are dominated by a substitution effect of money holdings for capital holdings, as an increase in the inflation rate due to money growth raises the cost of holding money and depresses the real money holdings. Using a monetary endogenous growth model, the effects of wealth‐induced social status on long‐run growth is reconsidered. The analysis is enhanced through the addition of a competitive banking sector that intermediates the available capital in the economy, subject to a mandatory cash reserve requirement. The cash reserve requirement creates a wedge between the deposit rate and the loan rate. While the real loan rate is tied with the constant marginal product of capital, the real deposit rate is negatively related to the rate of inflation. This leads to another, opposing substitution effect of deposit holdings for real money holdings and hence, increases the cost of holding deposits as inflation increases. The consolidated theoretical model described herein supports a diverse range of theoretical findings, contingent on the presence of wealth effects or the spirit of capitalism, using a simpler and more tractable framework that accounts for the role of the banking system in monetary policy decision outcomes. Significantly, as long as the mandatory reserve requirement imposed on the banking system by the monetary authority exceeds a (small) critical value, an increase in the money growth rate will lead to a decrease in the long‐run growth rate of the economy.