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

  • 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))

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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File URL: http://www.imes.boj.or.jp/research/papers/english/08-E-19.pdf
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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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