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Inventory-Theoretic Model of Money Demand, Multiple Goods, and Price Dynamics

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Author Info
Hirokazu Ishise (Department of Economics, Boston University (E-mail: ishise@bu.edu))
Nao Sudo (Corresponding author, Institute for Monetary and Economic Studies, Bank of Japan (E-mail: nao.sudou@boj.or.jp))

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Abstract

Despite the theoretical prediction based on sticky-price models, it is empirically suggested that the tie between the frequencies of price adjustment across goods and the relative price responses of goods (price index of specific goods over non-durable aggregate price index) to a monetary policy change is limited.We offer an alternative view of the price dynamics of goods. We develop a multi-sector extension of an inventory-theoretic model of money demand (segmented market model). In our model, the diversity in the characteristics of goods, that is, durability, luxuriousness and cash intensity (the portion of the payment that is paid by cash in the purchase of goods), yields the dispersion of relative prices responses to a monetary policy shock, across goods. The model implies that the relative prices of durables, luxuries and less cash-intensive goods tend to decline in a monetary contraction. We test the empirical plausibility of our model, using two approaches: a measure of monetary policy shock developed by Romer and Romer (2004), and a factor-augmented VAR used in Bernanke et al. (2005). In both econometric methodologies, we find that the data are consistent with our model, in terms of durability and luxuriousness.

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Paper provided by Institute for Monetary and Economic Studies, Bank of Japan in its series IMES Discussion Paper Series with number 08-E-19.

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Date of creation: Aug 2008
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Handle: RePEc:ime:imedps:08-e-19

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Related research
Keywords: Baumol-Tobin model; Durable; Luxury; Credit goods; Monetary policy;

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Find related papers by JEL classification:
E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook

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