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Md/P=L(Y, i)
factors: (financial) innovations
productivity shock
Inflation is costly because of:
1. create menu costs of adjustment
2. shoe leather cost
3. wealth redistribution
4. households find it hard to plan for the future (e.g. write nominal contracts) when prices vary
How they can do this: endogenous money creation (changing money supply)
Individuals make decisions on the basis of the real interest rates.
Choices made on the basis of an expected inflation rate.
@impact on bond market: r=i because the rate of return is explained by the real value term
@impact on money market: money demand still driven by [nominal interest rate]
@impact on labor and capital market: no effect on MPK, kK (capital utilization), MPL
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