INSIDE MONEY AND MONETARY NEUTRALITY

Interaction between the financial and real sectors of the economy is examined in a stochastic, rational expectations model that distinguishes between inside and outside money. Financial sector disturbances and temporary shocks to the monetary base are shown to have real effects even when private agents have complete information and prices are flexible. The central economic mechanism underlying our model is that substitution between inside and outside money as media of exchange affects the flow of funds from financial intermediaries to firms and therefore real interest rates, investment and output. © 1991.