Inflation and Output in a Cash Constrained Economy

We examine permanent effects of monetary expansion in an economy where access to credit for financing consumption and investment is limited and consumers and firms are cash-constrained. The main difference between our model with those of Cooley-Hanson (1989) and Walsh (2003) is that investment, in addition to consumption, is subject to a cash-constraint. In this respect, our model is similar to Stockman (1981) and Abel (1985) but different from them in that they do not provide for labor-leisure choice. Moreover, in contrast to Stockman and Abel we follow Svensson s (1985) timing sequence in that the asset market opens after the goods market. A version of Cooley and Hanson model is calibrated with the data on the economy of Iran. We compare the business cycles and output and consumption moments generated from simulated data to the moments extracted from the actual data. From the impulse-response functions we also derive the effect of a positive monetary shock on output and inflation.