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IMF - The Chicago Plan Revisited

# IMF - The Chicago Plan Revisited

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11/06/2012

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Manufacturers have unit mass and are indexed by j. Each buyer of manufacturing output
demands a CES composite of goods varieties with elasticity of substitution θ, so that
manufacturers’ gross steady state markup of their nominal price Pt(j) over nominal
marginal cost MCt equals µ = θ/(θ−1). Manufacturers face price adjustment costs
CP,t(i) that, as in Ireland (2001), make it costly for them to change the rate of price
inﬂation: CP,t(i) = φp

2 yt

Pt(j)
Pt−1(j)/Pt−1

Pt−2 −1 2

. Demand for manufacturers’ output is given

by yt(j) = yt(Pt(j)/Pt)−θ

, while their technology is given by a standard Cobb-Douglas

production function in labor and capital yt(j) = (Ttht(j))1−α

kt−1(j)α

. Manufacturers

need to maintain bank deposits to minimize the transactions costs associated with
payments for their inputs. They ﬁnance deposits partly out of their own net worth, and
partly by borrowing from banks, with their balance sheet constraint given by

ˇdm
t
= ˇℓm

t + ˇnm

t .

(15)

Manufacturers’ time t optimization problem, in nominal terms, is

Max

Pt(j),ht(j),kt(j),Dm

t (j),¯ωm

t+1(j),˜λm

t (j) Et

Pt(j)yt

Pt(j)
Pt

θ

+ (1−Γm,t+1)id,tDm

t (j)

+MCt

(TtSa

t ht(j))1−α

kt−1(j)α

yt

Pt(j)
Pt

θ

−(Wtht(j) +Rk,tkt−1(j))(1 +sm

t (j))

PtTtF−PtCP,t(i)]− 1
iℓ
tPt
+1CP,t+1(i)

λm

t+1(j)[(Γm,t+1(j)−ξm

Gm,t+1(j))Dm

t (j)id,tiℓ,tDm

t (j) +iℓ,tNm

t (j)] + ...

31

The ﬁrst line shows sales revenues plus earnings on deposits net of the share going to
banks. This latter expression is familiar from our general exposition of the optimal loan
contract in subsection III.B. The second line imposes the constraint that supply equals
demand for good j. The term on the third line is the input cost of labor and capital, with
an added transaction costs term that depends on the amount of deposits held. The ﬁrst
term on the fourth line is a ﬁxed cost, and the remaining terms are inﬂation adjustment
costs. The ﬁfth line is the bank participation constraint.

We assume that all manufacturers have identical initial stocks of bank deposits, loans and
net worth. In that case all manufacturers make identical choices in equilibrium, and we
can drop the index j in what follows. The optimality conditions for price setting and
input choice are standard, except for the presence of a monetary wedge in marginal cost
terms. They are shown in the Technical Appendix. We list here only the condition for the
optimal loan contract for working capital loans:

Et

(1−Γm,t+1)id,t +sm

t (vm

t )2 + ˜λm

t+1

Γm,t+1 −Sx

t+1ξm

t+1Gm,t+1 id,tiℓ,t = 0 .

(16)

Similar to the condition for the optimal consumer loan contract, this features a monetary
wedge, but it is otherwise identical to the optimality condition for investment loans (6).

Finally, the net worth accumulation of manufacturers is given by

ˇnm

t = rd,t

x ˇdm

t−1 (1−ξm

Gm,t) + ˇΛm

t rℓ,t

x ˇℓm

t−1

(17)

yt− ˇwtht +rk,t

ˇkt−1
x

(1 +sm

t )− ˇCP,t−F−δm

ˇnm

t .

The terms on the ﬁrst line represent the net cash ﬂow from debt-ﬁnanced investment in
bank deposits, with ξm

Gm,t denoting the share of gross returns spent on monitoring costs,

and ˇΛm

t representing banks’ net losses (and thus borrowers’ gains) on the loan. The terms
on the second line represent the net cash ﬂow from goods production, including a ﬁxed
cost F, minus the dividend payment.

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