LIQUIDITY, LOANABLE FUNDS, AND REAL ACTIVITY

This paper develops a general equilibrium model of two traditional explanations of the monetary 'black box' linking money and real activity: the liquidity effect and the loanable funds effect. These effects are modeled with a monetary production economy in which central bank injections of cash are funnelled into the economy through the credit market. Since only borrowers have direct access to the newly injected cash, monetary injections cause nominal interest rates to fall. If firms are borrowers, then monetary injections also increase current and future real activity.