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Inflation dynamics and the cost channel of monetary transmission

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  • Chowdhury, Ibrahim
  • Hoffmann, Mathias
  • Schabert, Andreas

Abstract

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. Since firms' costs of working capital increase with interest rates, we augment a (hybrid) New Keynesian Phillips curve by including the short-run nominal interest rate. We find significant and varying direct interest rate effects for the majority of countries, including member countries of the EMU. Simulations further demonstrate that the estimated interest rate coefficients can substantially affect inflation responses to monetary policy shocks, and can even lead to inverse inflation responses, when the cost channel is - relative to the demand channel - sufficiently strong

Suggested Citation

  • Chowdhury, Ibrahim & Hoffmann, Mathias & Schabert, Andreas, 2004. "Inflation dynamics and the cost channel of monetary transmission," CFR Working Papers 04-01, University of Cologne, Centre for Financial Research (CFR).
    • Handle: RePEc:zbw:cfrwps:0401
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    More about this item

    Keywords

    New Keynesian Phillips Curve; Working Capital; Financial Market Imperfections; Price Puzzle; Commodity Prices;
    All these keywords.

    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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