Staff Report 417

Sluggish Responses of Prices and Inflation to Monetary Shocks in an Inventory Model of Money Demand

Andrew Atkeson | Federal Reserve Bank of Minneapolis Consultant and UCLA
Fernando Alvarez | University of Chicago
Chris Edmond

Published November 14, 2008

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.

RELATED PAPER: Technical Appendix

Published In: Quarterly Journal of Economics (Vol. 124, No. 3, 2009, pp. 911-967)

Download Paper (pdf)