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Inflation and Interest Rates with Endogenous Market Segmentation

  • Julia K. Thomas
  • Aubhik Khan

The authors examine a monetary economy where households incur fixed transactions costs when exchanging bonds and money and, as a result, carry money balances in excess of current spending to limit the frequency of such trades. As only a fraction of households choose to actively trade bonds and money at any given time, the market is endogenously segmented. Moreover, because households in this model economy have the ability to alter the timing of their trading activities, the extent of market segmentation varies over time in response to real and nominal shocks. The authors find that this added flexibility can substantially reinforce both sluggishness in aggregate price adjustment and the persistence of liquidity effects in real and nominal interest rates relative to that seen in models with exogenously segmented markets.

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Paper provided by Society for Economic Dynamics in its series 2005 Meeting Papers with number 170.

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Date of creation: 2005
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Handle: RePEc:red:sed005:170
Contact details of provider: Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
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Web page: http://www.EconomicDynamics.org/society.htm
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  1. Eric M. Leeper & Christopher A. Sims & Tao Zha, 1996. "What Does Monetary Policy Do?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 27(2), pages 1-78.
  2. Fernando Alvarez & Andrew Atkeson & Chris Edmond, 2008. "Sluggish responses of prices and inflation to monetary shocks in an inventory model of money demand," Staff Report 417, Federal Reserve Bank of Minneapolis.
  3. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 1998. "Monetary Policy Shocks: What Have We Learned and to What End?," NBER Working Papers 6400, National Bureau of Economic Research, Inc.
  4. Williamson, Stephen D., 2008. "Monetary policy and distribution," Journal of Monetary Economics, Elsevier, vol. 55(6), pages 1038-1053, September.
  5. Emi Nakamura & Jón Steinsson, 2008. "Five Facts about Prices: A Reevaluation of Menu Cost Models," The Quarterly Journal of Economics, MIT Press, vol. 123(4), pages 1415-1464, November.
  6. Fernando Alvarez & Andrew Atkeson & Patrick J. Kehoe, 2000. "Money, interest rates, and exchange rates with endogenously segmented markets," Staff Report 278, Federal Reserve Bank of Minneapolis.
  7. Robert G. King & Julia K. Thomas, . "Partial Adjustment without Apology," GSIA Working Papers 1999-E12, Carnegie Mellon University, Tepper School of Business.
  8. Chiu, Jonathan, 2014. "Endogenously Segmented Asset Market In An Inventory-Theoretic Model Of Money Demand," Macroeconomic Dynamics, Cambridge University Press, vol. 18(02), pages 438-472, March.
  9. Fernando Alvarez & Robert E. Lucas & Warren E. Weber, 2001. "Interest Rates and Inflation," American Economic Review, American Economic Association, vol. 91(2), pages 219-225, May.
  10. V. V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 1998. "Sticky price models of the business cycle: can the contract multiplier solve the persistence problem?," Staff Report 217, Federal Reserve Bank of Minneapolis.
  11. Chatterjee, Satyajit & Corbae, Dean, 1992. "Endogenous Market Participation and the General Equilibrium Value of Money," Journal of Political Economy, University of Chicago Press, vol. 100(3), pages 615-46, June.
  12. Michael Dotsey & Robert G. King & Alexander L. Wolman, 1999. "State-Dependent Pricing And The General Equilibrium Dynamics Of Money And Output," The Quarterly Journal of Economics, MIT Press, vol. 114(2), pages 655-690, May.
  13. Rotemberg, Julio J, 1984. "A Monetary Equilibrium Model with Transactions Costs," Journal of Political Economy, University of Chicago Press, vol. 92(1), pages 40-58, February.
  14. Grossman, Sanford & Weiss, Laurence, 1983. "A Transactions-Based Model of the Monetary Transmission Mechanism," American Economic Review, American Economic Association, vol. 73(5), pages 871-80, December.
  15. Filippo Occhino, 2004. "Modeling the Response of Money and Interest Rates to Monetary Policy Shocks: A Segmented Markets Approach," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 7(1), pages 181-197, January.
  16. Julia K. Thomas, 2002. "Is lumpy investment relevant for the business cycle?," Staff Report 302, Federal Reserve Bank of Minneapolis.
  17. Fernando Alvarez & Andrew Atkeson & Chris Edmond, 2003. "On the Sluggish Response of Prices to Money in an Inventory-Theoretic Model of Money Demand," NBER Working Papers 10016, National Bureau of Economic Research, Inc.
  18. Mark Bils & Peter J. Klenow, 2004. "Some Evidence on the Importance of Sticky Prices," Journal of Political Economy, University of Chicago Press, vol. 112(5), pages 947-985, October.
  19. Annette Vissing-Jorgensen, 2002. "Towards an Explanation of Household Portfolio Choice Heterogeneity: Nonfinancial Income and Participation Cost Structures," NBER Working Papers 8884, National Bureau of Economic Research, Inc.
  20. Occhino, Filippo, 2008. "Market Segmentation And The Response Of The Real Interest Rate To Monetary Policy Shocks," Macroeconomic Dynamics, Cambridge University Press, vol. 12(05), pages 591-618, November.
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