Summary

This study investigates the long run interaction of inflation and real economic activity as traditionally addressed in the literature on money and growth. In a prominent contribution to this literature, Tobin (1965) arrives at the well-known result that one should expect inflation and economic activity to be positively correlated. Importantly, this so-called Tobin effect hinges critically on the assumption that money and capital enter the portfolios of agents as substitutes: with inflation acting like a tax on real balances, this assumption ensures that a more inflationary policy induces a portfolio shift from money to capital, thereby leading to a higher level of overall activity. More recently, however, empirical and theoretical studies have challenged this view.