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Inflation and interest rates with endogenous market segmentation

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  • Aubhik Khan
  • Julia Thomas

Abstract

The authors examine a monetary economy where households incur fixed transactions costs when exchanging bonds and money and, as a result, carry money balances in excess of current spending to limit the frequency of such trades. As only a fraction of households choose to actively trade bonds and money at any given time, the market is endogenously segmented. Moreover, because households in this model economy have the ability to alter the timing of their trading activities, the extent of market segmentation varies over time in response to real and nominal shocks. The authors find that this added flexibility can substantially reinforce both sluggishness in aggregate price adjustment and the persistence of liquidity effects in real and nominal interest rates relative to that seen in models with exogenously segmented markets.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Philadelphia in its series Working Papers with number 07-1.

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Date of creation: 2007
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Handle: RePEc:fip:fedpwp:07-1

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  1. Fernando Alvarez & Andrew Atkeson & Chris Edmond, 2008. "Sluggish responses of prices and inflation to monetary shocks in an inventory model of money demand," Staff Report, Federal Reserve Bank of Minneapolis 417, Federal Reserve Bank of Minneapolis.
  2. V. V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 1998. "Sticky price models of the business cycle: can the contract multiplier solve the persistence problem?," Staff Report, Federal Reserve Bank of Minneapolis 217, Federal Reserve Bank of Minneapolis.
  3. Julia K. Thomas, . "Is Lumpy Investment Relevant for the Business Cycle?," GSIA Working Papers, Carnegie Mellon University, Tepper School of Business 1998-E250, Carnegie Mellon University, Tepper School of Business.
  4. Robert G. King & Julia K. Thomas, . "Partial Adjustment without Apology," GSIA Working Papers, Carnegie Mellon University, Tepper School of Business 1999-E12, Carnegie Mellon University, Tepper School of Business.
  5. Chatterjee, S. & Corbae, D., 1990. "Endogenous Market Participation and the General Equelibrium Value of Money," Working Papers, University of Iowa, Department of Economics 90-30a, University of Iowa, Department of Economics.
  6. Julio J. Rotemberg, 1982. "A Monetary Equilibrium Model with Transactions Costs," NBER Working Papers 0978, National Bureau of Economic Research, Inc.
  7. Fernando Alvarez & Andrew Atkeson & Patrick J. Kehoe, 2000. "Money, interest rates, and exchange rates with endogenously segmented markets," Staff Report, Federal Reserve Bank of Minneapolis 278, Federal Reserve Bank of Minneapolis.
  8. Christiano, Lawrence J. & Eichenbaum, Martin & Evans, Charles L., 1999. "Monetary policy shocks: What have we learned and to what end?," Handbook of Macroeconomics, Elsevier, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 2, pages 65-148 Elsevier.
  9. Annette Vissing-Jorgensen, 2002. "Towards an Explanation of Household Portfolio Choice Heterogeneity: Nonfinancial Income and Participation Cost Structures," NBER Working Papers 8884, National Bureau of Economic Research, Inc.
  10. Fernando Alvarez & Andrew Atkeson & Chris Edmond, 2003. "On the Sluggish Response of Prices to Money in an Inventory-Theoretic Model of Money Demand," NBER Working Papers 10016, National Bureau of Economic Research, Inc.
  11. Jonathan Chiu, 2005. "Endogenously Segmented Asset Market in an Inventory Theoretic Model of Money Demand," 2005 Meeting Papers, Society for Economic Dynamics 108, Society for Economic Dynamics.
  12. Emi Nakamura & Jón Steinsson, 2008. "Five Facts about Prices: A Reevaluation of Menu Cost Models," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 123(4), pages 1415-1464, November.
  13. Michael Dotsey & Robert G. King & Alexander L. Wolman, 1999. "State-Dependent Pricing And The General Equilibrium Dynamics Of Money And Output," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 114(2), pages 655-690, May.
  14. Williamson, Stephen D., 2008. "Monetary policy and distribution," Journal of Monetary Economics, Elsevier, Elsevier, vol. 55(6), pages 1038-1053, September.
  15. Occhino, Filippo, 2008. "Market Segmentation And The Response Of The Real Interest Rate To Monetary Policy Shocks," Macroeconomic Dynamics, Cambridge University Press, Cambridge University Press, vol. 12(05), pages 591-618, November.
  16. Fernando Alvarez & Robert E. Lucas & Warren E. Weber, 2001. "Interest Rates and Inflation," American Economic Review, American Economic Association, American Economic Association, vol. 91(2), pages 219-225, May.
  17. Mark Bils & Peter J. Klenow, 2004. "Some Evidence on the Importance of Sticky Prices," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 112(5), pages 947-985, October.
  18. Filippo Occhino, 2004. "Modeling the Response of Money and Interest Rates to Monetary Policy Shocks: A Segmented Markets Approach," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 7(1), pages 181-197, January.
  19. Grossman, Sanford & Weiss, Laurence, 1983. "A Transactions-Based Model of the Monetary Transmission Mechanism," American Economic Review, American Economic Association, American Economic Association, vol. 73(5), pages 871-80, December.
  20. Eric M. Leeper & Christopher A. Sims & Tao Zha, 1996. "What Does Monetary Policy Do?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, Economic Studies Program, The Brookings Institution, vol. 27(2), pages 1-78.
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Citations

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Cited by:
  1. Stephen D. Williamson, 2005. "Monetary Policy and Distribution," 2005 Meeting Papers, Society for Economic Dynamics 379, Society for Economic Dynamics.
  2. Greg Kaplan & Giovanni L. Violante, 2011. "A Model of the Consumption Response to Fiscal Stimulus Payments," NBER Working Papers 17338, National Bureau of Economic Research, Inc.
  3. Chiu, Jonathan & Molico, Miguel, 2010. "Liquidity, redistribution, and the welfare cost of inflation," Journal of Monetary Economics, Elsevier, Elsevier, vol. 57(4), pages 428-438, May.
  4. Lucy Qian Liu & Liang Wang & Randall Wright, 2009. "“On the ‘Hot Potato Effect’ of Inflation: Intensive versus Extensive Margins”," PIER Working Paper Archive, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania 09-040, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
  5. Christopher Gust & David Lopez-Salido, 2010. "Monetary policy and the cyclicality of risk," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 999, Board of Governors of the Federal Reserve System (U.S.).
  6. Bridges, Jonathan & Thomas, Ryland, 2012. "The impact of QE on the UK economy – some supportive monetarist arithmetic," Bank of England working papers, Bank of England 442, Bank of England.
  7. Fernando Alvarez & Andrew Atkeson & Chris Edmond, 2009. "Sluggish Responses of Prices and Inflation to Monetary Shocks in an Inventory Model of Money Demand," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 124(3), pages 911-967, August.
  8. Jonathan Chiu & Miguel Molico, 2008. "Uncertainty, Inflation, and Welfare," Working Papers, Bank of Canada 08-13, Bank of Canada.
  9. Hirokazu Ishise & Nao Sudo, 2008. "Inventory-Theoretic Model of Money Demand, Multiple Goods, and Price Dynamics," IMES Discussion Paper Series, Institute for Monetary and Economic Studies, Bank of Japan 08-E-19, Institute for Monetary and Economic Studies, Bank of Japan.
  10. Yi Wen, 2009. "When does heterogeneity matter?," Working Papers, Federal Reserve Bank of St. Louis 2009-024, Federal Reserve Bank of St. Louis.
  11. Stephen D. Williamson, 2009. "Transactions, Credit, and Central Banking in a Model of Segmented Markets," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 12(2), pages 344-362, April.
  12. Andre C. Silva, 2011. "Individual and Aggregate Money Demands," FEUNL Working Paper Series, Universidade Nova de Lisboa, Faculdade de Economia wp557, Universidade Nova de Lisboa, Faculdade de Economia.
  13. Zervou, Anastasia S., 2013. "Financial market segmentation, stock market volatility and the role of monetary policy," European Economic Review, Elsevier, Elsevier, vol. 63(C), pages 256-272.
  14. Nao Sudo, 2011. "Accounting for the Decline in the Velocity of Money in the Japanese Economy," IMES Discussion Paper Series, Institute for Monetary and Economic Studies, Bank of Japan 11-E-16, Institute for Monetary and Economic Studies, Bank of Japan.
  15. Landon-Lane, John & Occhino, Filippo, 2008. "Bayesian estimation and evaluation of the segmented markets friction in equilibrium monetary models," Journal of Macroeconomics, Elsevier, Elsevier, vol. 30(1), pages 444-461, March.

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