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Sluggish responses of prices and inflation to monetary shocks in an inventory model of money demand

Author

Listed:
  • Fernando Alvarez
  • Andrew Atkeson
  • Chris Edmond

Abstract

We examine the responses of prices and inflation to monetary shocks in an inventory-theoretic model of money demand. We show that the price level responds sluggishly to an exogenous increase in the money stock because the dynamics of households' money inventories leads to a partially offsetting endogenous reduction in velocity. We also show that inflation responds sluggishly to an exogenous increase in the nominal interest rate because changes in monetary policy affect the real interest rate. In a quantitative example, we show that this nominal sluggishness is substantial and persistent if inventories in the model are calibrated to match U.S. households' holdings of M2.

Suggested Citation

  • Fernando Alvarez & Andrew Atkeson & Chris Edmond, . "Sluggish responses of prices and inflation to monetary shocks in an inventory model of money demand," Staff Report, Federal Reserve Bank of Minneapolis.
    • Handle: RePEc:fip:fedmsr:417
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    Cited by:

    1. Wen, Yi, 2015. "Money, liquidity and welfare," European Economic Review, Elsevier, vol. 76(C), pages 1-24.
    2. Telyukova, Irina A. & Visschers, Ludo, 2009. "Precautionary Demand for Money in a Monetary Business Cycle Model," MPRA Paper 15622, University Library of Munich, Germany.
    3. Edward Nelson, 2008. "Why Money Growth Determines Inflation in the Long Run: Answering the Woodford Critique," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(8), pages 1791-1814, December.
    4. Telyukova, Irina A. & Visschers, Ludo, 2013. "Precautionary money demand in a business-cycle model," Journal of Monetary Economics, Elsevier, vol. 60(8), pages 900-916.
    5. Yi Wen, 2012. "Liquidity and welfare," Working Papers 2012-037, Federal Reserve Bank of St. Louis.
    6. Bernardino Adão & André C. Silva, 2012. "Welfare costs of inflation with distortionary taxation," Economic Bulletin and Financial Stability Report Articles and Banco de Portugal Economic Studies, Banco de Portugal, Economics and Research Department.

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    Keywords

    Demand for money; Prices; Inflation (Finance);
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