Firm's Demand for Money: Feenstra Equivalence, Monetary Super-Neutrality and Techincal Inefficiency

Abstract

This study investigates the implications of firm's demand for real balances from the production and monetary economics perspective. Money is a component of production as a factor increasing efficiency in exchange in input markets. Firms may improve efficiency in production by holding real money to decrease their transactions cost in input market. Feenstra (1986) equivalence states that transactions cost as a cosntraint in a firm's budget is functional equivalent to money in the production fucntion. Monetary expansion may change transactions cost, hence can affect the efficiency in both goods and input markets. If a monetary model is setup in accordence with Feenstra equivalence it can be used to examine the impact of the change in money supply over net consumption and net input. Monetary expansion is no longer super-neutral over net consumption and net input because it has the ability to alter efficiency in exchange. The study concludes with an empirical test on the theory by applying the stochastic production frontier approach over 12 EU countries. The test verifies the significance of real money in determining the technical inefficiency in production.