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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. 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.
  2. Robert G. King & Julia K. Thomas, 2003. "Partial Adjustment without Apology," NBER Working Papers 9946, National Bureau of Economic Research, Inc.
  3. 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.
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  7. 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.
  8. Chatterjee, Satyajit & Corbae, Dean, 1992. "Endogenous Market Participation and the General Equilibrium Value of Money," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 100(3), pages 615-46, June.
  9. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 1998. "Monetary Policy Shocks: What Have We Learned and to What End?," NBER Working Papers 6400, National Bureau of Economic Research, Inc.
  10. Julia K. Thomas, 2002. "Is lumpy investment relevant for the business cycle?," Staff Report, Federal Reserve Bank of Minneapolis 302, Federal Reserve Bank of Minneapolis.
  11. Grossman, Sanford & Weiss, Laurence, 1983. "A Transactions-Based Model of the Monetary Transmission Mechanism," American Economic Review, American Economic Association, vol. 73(5), pages 871-80, December.
  12. Williamson, Stephen D., 2008. "Monetary policy and distribution," Journal of Monetary Economics, Elsevier, vol. 55(6), pages 1038-1053, September.
  13. Fernando Alvarez & Robert E. Lucas & Warren E. Weber, 2001. "Interest Rates and Inflation," American Economic Review, American Economic Association, vol. 91(2), pages 219-225, May.
  14. 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, vol. 27(2), pages 1-78.
  15. 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.
  16. 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.
  17. 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.
  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, vol. 7(1), pages 181-197, January.
  19. Jonathan Chiu, 2007. "Endogenously Segmented Asset Market in an Inventory Theoretic Model of Money Demand," Working Papers 07-46, Bank of Canada.
  20. 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.
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Citations

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Cited by:
  1. 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.).
  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. Jonathan Chiu & Miguel Molico, 2011. "Uncertainty, Inflation, and Welfare," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 43, pages 487-512, October.
  4. Chiu, Jonathan & Molico, Miguel, 2010. "Liquidity, redistribution, and the welfare cost of inflation," Journal of Monetary Economics, Elsevier, vol. 57(4), pages 428-438, May.
  5. Stephen D. Williamson, 2005. "Monetary Policy and Distribution," 2005 Meeting Papers 379, Society for Economic Dynamics.
  6. Zervou, Anastasia S., 2013. "Financial market segmentation, stock market volatility and the role of monetary policy," European Economic Review, Elsevier, vol. 63(C), pages 256-272.
  7. Stephen D. Williamson, 2006. "Transactions, Credit, and Central Banking in a Model of Segmented Markets," 2006 Meeting Papers, Society for Economic Dynamics 287, Society for Economic Dynamics.
  8. 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.
  9. Andre C. Silva, 2011. "Individual and Aggregate Money Demands," FEUNL Working Paper Series wp557, Universidade Nova de Lisboa, Faculdade de Economia.
  10. Yi Wen, 2009. "When does heterogeneity matter?," Working Papers 2009-024, Federal Reserve Bank of St. Louis.
  11. Landon-Lane, John & Occhino, Filippo, 2008. "Bayesian estimation and evaluation of the segmented markets friction in equilibrium monetary models," Journal of Macroeconomics, Elsevier, vol. 30(1), pages 444-461, March.
  12. Liu, Lucy Qian & Wang, Liang & Wright, Randall, 2011. "On The “Hot Potato” Effect Of Inflation: Intensive Versus Extensive Margins," Macroeconomic Dynamics, Cambridge University Press, Cambridge University Press, vol. 15(S2), pages 191-216, September.
  13. Bridges, Jonathan & Thomas, Ryland, 2012. "The impact of QE on the UK economy – some supportive monetarist arithmetic," Bank of England working papers 442, Bank of England.
  14. Nao Sudo, 2011. "Accounting for the Decline in the Velocity of Money in the Japanese Economy," IMES Discussion Paper Series 11-E-16, Institute for Monetary and Economic Studies, Bank of Japan.
  15. Hirokazu Ishise & Nao Sudo, 2008. "Inventory-Theoretic Model of Money Demand, Multiple Goods, and Price Dynamics," IMES Discussion Paper Series 08-E-19, Institute for Monetary and Economic Studies, Bank of Japan.

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