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Chain of production as a monetary propagation mechanism

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  • Kevin X. D. Huang
  • Zheng Liu

Abstract

This paper studies a general equilibrium model with multiple stages of production and asynchronized price setting that provides a new explanation for the observed persistent real effects of monetary shocks. The key feature of the model is a vertical chain-of-production structure. In this model, the effects of monetary shocks on price adjustment are gradually dampened via the interactions of firms through their input-output relations and the timing of their price decisions. The model predicts that prices adjust by a smaller amount and less rapidly at later stages than at earlier stages, which is supported by empirical evidence. More importantly, an increase in the total number of stages in the model leads to not only uniformly larger and longer-lasting real effects but also flatter paths of aggregate output response. With sufficiently many stages, the price level adjustment becomes arbitrarily close to zero and the aggregate output tends to carry the full burden of adjustment. Thus, the chain-of-production mechanism goes a long way in propagating the shocks.

Suggested Citation

  • Kevin X. D. Huang & Zheng Liu, 1999. "Chain of production as a monetary propagation mechanism," Discussion Paper / Institute for Empirical Macroeconomics 130, Federal Reserve Bank of Minneapolis.
  • Handle: RePEc:fip:fedmem:130
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    Cited by:

    1. Kevin Huang & Z. Liu, "undated". "Vertical international trade as a monetary transmission mechanism in an open economy," Working Papers 2000-07, Utah State University, Department of Economics.
    2. Huang, Kevin X. D. & Liu, Zheng, 2001. "Production chains and general equilibrium aggregate dynamics," Journal of Monetary Economics, Elsevier, vol. 48(2), pages 437-462, October.
    3. Smets, Frank & Wouters, Raf, 2002. "Openness, imperfect exchange rate pass-through and monetary policy," Journal of Monetary Economics, Elsevier, vol. 49(5), pages 947-981, July.

    More about this item

    Keywords

    Econometric models;

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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