Inside money, credit, and investment

This paper presents a monetary explanation for several business-cycle facts: (i) household and business investment are procyclical, (ii) business investment lags household investment, (iii) household investment is positively correlated with M1, and (iv) household credit outstanding is positively correlated with and more volatile than household investment. We extend a standard, dynamic general equilibrium model to include financial intermediaries, credit-producing firms, and inside (bank-created) money. The transmission of monetary shocks facilitated by credit and inside money creation in the model is able to reconcile these real and monetary observations regarding the cyclical behavior of investment.