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Inflation Dynamics and the Cost Channel of Monetary Transmission

  • Ibrahim Chowdhury

    (University of Cologne)

  • Mathias Hoffmann

    (University of Cologne)

  • Andreas Schabert

    (University of Cologne)

Evidence from vector autoregressions indicates that the impact of interest rate shocks on macroeconomic aggregates can substantially be affected by the so-called cost channel of monetary transmission. In this paper we apply a structural approach to examine the relevance of the cost channel for inflation dynamics in G7 countries. We augment the so-called hybrid New Keynesian Philips curve by letting firms’ costs for external funds rise with the short-run nominal interest rate. Our estimates reveal that the magnitude of this cost channel strongly varies between countries, including member countries of the EMU, in accordance with differences in their financial systems. Simulations of a New Keynesian model further show that the presence of the cost channel substantially affects the transmission of monetary policy shocks, in particular, the inflation response.

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Paper provided by Money Macro and Finance Research Group in its series Money Macro and Finance (MMF) Research Group Conference 2004 with number 18.

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Date of creation: 17 Sep 2004
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Handle: RePEc:mmf:mmfc04:18
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