Miss Sabbah Gueddoudj

Researcher at the G.E.K.E.M.

Professional address : 54, boulevard Desgranges
92 SCEAUX
00 33 1 40 91 17 32
Private address : 04, rue des maraîchers
95 SANNOIS
00 33 1 34 15 77 70
E-mail : gueddoudj@hotmail.com

Firms’cash in advance contrainst and endogenous growth.

 Abstract
The aim of this article is on the one hand to introduce firms’ C.I.A. constrainst in an
endogenous growth model which included money as a good producer and to demonstrate that
in this framework the capital accumulation needs cash in advance balances. Money is
therefore not superneutral and the monetary policy influences the productive sphere.

Keywords : cash in advance contrainst, endogenous growth, inflation, money input, steady
equilibrium, superneutrality.

JEL : E5, 04.

Most of economic monetary theories suppose that householders need cash in advance
for their purchases, they often neglect the firms’behaviour. Firms like householders are
submitted to cash in advance contrainst. Indeed, there is a postponement between income and
purchases. An amount of cash recieved at time t is not spent at once. So one has to take into
account delays needed to spend this cash.
Several growth theoricians introduce the C.I.A. constrainst in their model but they
suppose it only for householders. In this work, one will deal with cash contrainst undergone
by firms.

This article is organised as fellows. The first section present the frame work of an
endogenous growth model included firms’CIA contrainst. The section two analyses the
resolution of the model and the last one is consacred to comments.

Section I Presentation of the model

One assumes that two kind of money exist. The distinction is based on the duration of
the money in the portfolio. One will be used to pay salaries (m 1) and the other to finance
invesments (m2). So two different money velocity are defined (1/v1 for m1 and 1/v2 for m2).
Besides, one supposes that householders spend all their income in good and services
purchases.
The two kind of contrainst submitted by firms are defined as fellows :

v1 I k  m1 (1)
v2 c  m2 (2)

Where Ik is the invesments in physical capital

c the consumption

To simplify, those two money are assumed substituable, so :

m(t)=m1(t)+m2(t) (3)

The endogenous growth model included firms’cash contrainst is :

 U ( c(t )) e
 t
max W  dt (4)
0

s.c

m (t )  y( t )  c (t )  I k ( t )   ( m1 ( t )  m2 ( t ))    nk (5)
v1 I k (t )  (1   ) m1 (t ) (6)
v2 c (t )  (1   )m 2 (t ) (7)

k  I k (t ) (8)
Where c consumption
 actualisation rate
p prices
r remuneration of capital (real interest rate)
i remuneration of money (nominal rate)
m real money balances
m money for the acquisition of invesments
1

m money for the salaries

2

v et v duration of the two different money in the portfolio

1 2

I physical capital invesment

K

1-μ the share measuring the quantity of cash in advance balances.

μЄ]0,1].

The production function is a Cobb Douglas function included three producer goods,
efficient labor, capital and real money balances. μ is the share of money reserved to
precautionary and speculative motives.

F (k (t ), h(t ), m(t ))  Ak  (t ) h  (t )( m(t )) (9)

The utility function is a constant intertemporal elasticity of substitution :

1
1

c
U (c (t ))  (10)
1
1


To solve this model one have to write the Hamiltonian equation.

Section II Resolution of the model

The constraint of accumulation (5) and the intertemporal consumption function (4) can be
rewritten :

 m2 m
m(t )  y  (1   )  (1   ) 1   ( m1  m2 )    nk (11)
v2 v1

 m 
W   U ( 2 ) e t (12)
0  v2 

The Hamiltonian programm is :

m2 m m m
  U( )   1( y  (1   ) 2  (1   ) 1  nk   (m1  m2 )   )   2 ((1   ) 1 ) (13)
v2 v2 v1 v1

With θ1 et θ2 adjoint variables of the accumulation of money and physical capital.

The first order conditions are :

U m 2  1 (1   ) (14)
v2

1 (1    v1 )   2 (1   ) (15)

2 
  1 ( f k  n)   (16)
2 2

1
 ( f m   )   (17)
1
 Along the steady growth equilibrium path, all economic and adjoint variables increase
at the same rate, therefore the growth rate prevailing in this economy is defined by the
following relation :


c  (1   ) f k  n 
    (18)
c  (1    v1 ) 

If one supposes no cash in advance constraint for invesment, one will find the famous
Rebelo’s relation :


c
  ( fk  n   ) (19)
c

Section III Comments

The introduction of cash in advance constraint leads to some interesting remarks.

There is a negative link between the growth rate of the economy and the nominal
interest. This latter represents a cost for the physical capital accumulation.

Indeed, the infation rate measures the gap between the return of capital and the return
of money, therefore the economic growth rate is :

with   f m  fk  i  r (20)

c  (1   ) f k  n 
    (21)
c  (1    v1 (i  r )) 

Thanks to this new expression, it is easy to notice that an important interest rate and/or
an increase of this variable have a negative effect on the growth rate. The explication lies in
the fact that real money balances supposed to be a good producer has got a cost measured by
the nominal interest rate (i). Assuming that capital accumulation needs cash in advance
balances, an increase of i discourages firms to hold a part of their wealth in liquid form ; the
invesments which need a cash advance constraint are therefore penalized. A decrease of
investment reduces the production, the employment and consequently the consumption.
Note that the negative relation between production and interest rate has been
underlined by several authors and Sims (1992) qualifies it as a stylized fact.

If one supposes that only consumption submits cash in advance constraint, so money is
superneutral, that is to say that a variation of the monetary growth rate has no impact on the
economic growth rate. Because according to Asako (1983) in this precise case capital, real
money balances and consumption variables are independant.

To finish, inflation reduces the economic growth rate. This point has been so many
time study by numerous authors, it is for that reason that one will not emphasize on this topic.

The model presented in this short article has a double aim, the first is to consider
money as an input, the second is to show that firms have to face cash in advance constraint
like householders. The introduction of these hypothesis in an endogenous growth model gives
an interesting result.
This model demonstrates that money is not superneutral. Since, an increase of
interest rate affects the growth rate of the economy. So firms prefer to be « liquid », well
invesments require cash in advance balances , an increase of i penalizes this variable and
therefore growth. This point is very important for the monetary policy.
The formalisation chosen opens to critism. One assumes that all money is held by
firms (they preserve a part for the precautionnary and speculation motives, they pay salaries
and finance invesments). The householders spend all their income in purchases. these
hypothesis are restrictive. But goals of this work are to introduce the real money balances in
the productive sphere, evaluate its effect on the growth and contribute to keep the debate
going on the question of the monetary superneutrality.
References

ASAKO, K. The utility function and the superneutrality on money on the transition path,
Econometrica, 51(5), 1593-1596.

CLOWER, R.J 1967. A Reconsideration of the microfundations of money, Werstern

Economic Journal, 6(4 ), 1-9.

ORPHANIDES A & SOLOW R. 1990. «Money, Inflation and Growth », Handbook of

Monetary Economics, North Holland, 223-261.

RAJHI T&VILLIEU P. 1993. Monnaie et Croissance endogène, Revue Economique, 3, 257-

286.

SIMS C.A. 1992. Interpreting the macroeconomic time series : The effects of monetary
policy, European Economic Review, 36, 975-1011.
SINAI A & STOKES H 1972. Real Money Balances : An Omitted Variable from the
Production Function ?, Review of Economics and Statistics, 54, 290-296.

TSIANG S.C. 1966. Walras law, Say’s law and liquidity preference in general equilibrium
analysis, International Economic Review ,33, 329-345.

VILLIEU P. 1993 Les modèles à encaisses préalables : un renouveau des fondements micro-
économiques de la macro-économie monétaire, Revue économique et politique, 5(103), 615-
691.