During most of the transition, the reduction in the interest rate together with
the increase in wages, makes all agents work with a larger capital to labor ratio.
For the constrained entrepreneur, the decrease in the cost of capital outweighs the
wage increase and his financial constraint is relaxed. This allows him to hire more
inputs (6 percent more capital and 3 percent more labor on impact) and to produce
more (3.4 percent more on impact) than what he did in the old steady state. As
he accumulates more assets, his financial constraint is also relaxed in the future
which allows him to maintain higher levels of production and to propagate the
effects of the shock over time. However, profits are small compared to his wealth
and assets still take the same time to reach the level in which he is unconstrained
(12 periods).
The average entrepreneur also takes advantage of the fall in the interest rate
since he is a borrower as well. He hires more capital and is able to produce more.
However, because he is financially unconstrained, the only effect that works for
him is the change in prices. This is why their use of inputs expand much less
than the constrained entrepreneurs. As Figure 6 shows, the initial increase in his
capital is about half of the one for the constrained entrepreneur. This means that
the marginal productivity of labor increases little for him and he does not change
labor much on impact (about six times less than the constrained entrepreneur).
Finally, the change in the relative price of inputs makes the rich entrepreneur
clearly worse off. He reduces his labor demand and consequently his output.8
Finally, Figure 7 presents the evolution of idle capital. It shows a decrease in
unused resources of above 8 percent. This is the reason why output and capital
used rise on impact. The increase in the ratio of liquid to illiquid government
liabilities reduces the cost of using capital and productive entrepreneurs can use
more funds to acquire capital. It is in this sense in which we believe this mechanism
works under any other reason for having idle capacity, such as uncertainty about
demand at the time of capacity decisions or costs of operating at full capacity.
The idea is that there exists this other cost related to the financing of productive
capital which an expansionary monetary policy is able to reduce.
5 conclusions
This paper analyzes two stylized facts, namely, the possibility of monetary shocks
significantly affecting economic activity and the persistence of these effects over
time. We first present evidence on how monetary policy shocks associated with
the Fed changing the composition of government liabilities may have an impact
on real activity through its effects on capacity utilization. We then build up an
8 Capital on this panel shows no movement because the grid at those levels of
wealth is very wide.
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